An Appraisal of Monetary Policy

The question now is: How will the proposed monetary policy help the Islamic economy to achieve its goals?

The money supply would be regulated by the central authority in accordance with the needs and goals of the Muslim society. The growth in M would be regulated to achieve the goal of attaining broad-based well-being and an optimum but realistic rate of growth within the context of price stability. This target growth in M could be achieved by generating the required growth in high-powered money through a combination of fiscal deficit and central bank lending to financial institutions. However, there could still be excessive or deficient expansion in money supply because of the effect of a number of variables which are difficult to predict or control. Such excesses or deficiencies could be evened out with the help of changes in central bank mudarabah advances to commercial banks, statutory reserve requirements and ceilings on credit ,expansion. It is assumed that the government would be committed to Islamic goals and would not adopt policies which conflict with them. It is also assumed that all government policies would converge on the achievement of these goals and that monopolistic and oligopolistic practices and structural rigidities would also be removed.

The created money or the profit arising from it would go mainly to the public exchequer to be utilised for social welfare objectives of eradicating poverty, attaining a high rate of economic growth and low rate of unemployment, and fostering socio-economic justice. It would not serve vested interests or contribute to concentration of wealth. Thus the implementation of this scheme would help to reduce concentration of wealth to the extent to which it is brought about by the commercial banking system in the capitalist society.

The government financial problems would also be solved partly because, firstly, additional interest-free resources would be made available to the government in the form of created money, and secondly, a certain proportion of all commercial bank demand deposits would also be made available to the government. This would carry a service charge which would be considerably smaller than the heavy interest burden which makes the rich richer through interest receipts and the poor poorer through additional taxes levied to service the public debt.

The scheme need not reduce the overall volume of funds available to the private sector. It would, however, lead to a redistribution of these funds through a reduction in inequalities of income and concentration of wealth and a dispersal of total credit among a larger number of people along with its reallocation among various sectors of the economy to ensure an adequate production and distribution of goods and services needed by the majority of the society in conformity with a value-oriented plan. Since a preponderant part of the financial needs of business would come out of equity there would be no fixed interest cost to be added by firms to the cost of goods.

The ability of the government to obtain funds without the high cost of interest along with the imperative that these funds be invested in projects of high social priority should help eradicate poverty, increase employment, provide essential social and economic services and raise the rate of economic growth to an appropriate level thus contributing to general social welfare.

Hence it appears that the proposed scheme would operate to the greater overall benefit of the economy and help the Islamic state to realise its short-term as well as long-term social and economic objectives.

Source: Money and Banking in Islam, Ziauddin Ahmed; Munawar Iqabal; M. Fahim Khan. Republished with permission.