Fiscal Policy & Economic Stabilization

In recent years fiscal policy has played an important role in stabilizing the economies of the West, especially after the great-depression of the 1930s. In an economy where the productive capacity is well developed, fiscal policy can play an important role in regulating aggregate demand. In such countries, developed tax and social welfare systems a low fiscal policy to work flexibly in combating inflation or deflation."

In an Islamic state the stability of the real value of money is considered to be obligatory and is essential if such an economy is to proceed smoothly on the path of development. Inflation may generate a distribution of income and wealth which by concentrating wealth and income in the hands of rich may be harmful to welfare of people. Deflationary conditions are also harmful. Ibn Khaldun observed long ago that if the Sultan stops his financial flows to the public, this will generate recession. Recently compensatory finance is found to be essential to prevent a fall in aggregate demand and supply. Fiscal policies to reduce aggregate demand and enhance productivity will be necessary when the economy is under inflationary conditions. To achieve economic stabilization efficiently a Muslim state, as any other state, needs flexible and elastic revenue and expenditure systems. Progressive taxes on income and expenditure as well as social security payments can act as automatic stabilizers for the economy. Discretionary measures may also be taken if they do not generate adverse effects for the economy.

Source: Fiscal Policy and Resource Allocation in Islam, Ziauddin Ahmed, Munawar Iqbal and M. Fahim Khan. Republished with permission.