Monetary Economics and Macroeconomic Model for an Islamic Economy

Abstract

This chapter discusses macroeconomic model that reflects economic features of an Islamic economy, implied in the Islamic system of property rights (elaborated in the literature on Fiqh al-Mal) and in the Islamic system of exchange (elaborated in the literature on Fiqh al-Buyu’). In the theoretical framework of a macroeconomic model, the theory of monetary economics and theory of monetary policy for an Islamic economy refer to the economy that is operating strictly under the Islamic system of property rights and Islamic rules of exchange in the market and beyond market. This chapter also discusses monetary economics and monetary policy for a contemporary Muslim economy that is only a Muslim economy operating on conventional economic principles but intends to convert its financial and monetary system to conform to Islamic principles of money and finance. This chapter gives a brief overview of the current practice of monetary economics in the Muslim economies that have partially introduced Islamic banking and finance and are in the process of adjusting their monetary policy framework to conform to Islamic principles.

Appendices

Appendix I: Beyond Market Economics in an Islamic Economy

Islamic economy is usually distinguished from capitalist economy because of the absence of interest. The fact is that this is not as important a distinction as the exchange “beyond market” is in the economic system of Islam. It will not be oversimplification to say that Islamic economic system has been comprehensively outlined in the Quran in the verses 261–281 of Chap. 2 (al-Baqarah). These verses say:

• 1. Allah has permitted Trade (2:275)

• 2. Allah has prohibited interest on loans (2:275); Allah destroys interest (2:276)

• 3. Allah gives increase for Sadaqat (charities) (2:276)

Read other 12 verses (2:262–274) before the above two verses. They all relate to Sadaqat . The verses 277–281 are about financial accommodation which is required to be beyond market (loans to carry no interest, recovery of loans to be postponed if debtor is in distress) and infaq (help to those who cannot benefit from market) emphasized. Besides above references, the two obligations repeatedly mentioned in the Quran are Salah (five times prayers) and Zakah . This shows two components of economic system in Islamic framework:

• 1. Market segment where people trade or exchange in the market what they own. The tool for this exchange will be price that will be determined by market in a fairly competitive environment. There is elaborate guidance from Sunnah about how to exchange conduct in the market and about rules to be followed for the exchange (explained in volumes of on Fiqh al-Buyu’ – understanding the trade in Islam). These principles, in jargon of conventional economics, boil down to nothing but that markets should be “free” and “competitive.” The only restriction on the market is that it will be free of riba. It is clear that Islamic economic system allows a market segment in the economy. Self-interest is recognized in Islam, and system of property rights elaborated in the literature on Fiqh al-Maal explains the sanctity of property rights, and the rules for the protection of this sanctity and how to exchange these rights are sufficient to create a strong market segment in the economy in the Islamic system. Gains implicit in exchange create market. The leading Islamic principle for market segment of the economy is “O you who have believed, do not consume one another’s wealth unjustly but only [in lawful] business by mutual consent. And do not kill yourselves or one another” (The Quran 4:29).

• 2. Beyond market segment where people exchange Sadaqat for divine pleasure. This is also trade or exchange and there is gain in this exchange also, but not in the market environment. It is an exchange of value for a counter value that does not come from the market but from beyond the market. This exchange is also created by divine command market and is approved by divine command. This exchange is an obligatory part of life of a Muslim.

In Islamic framework, this component is part of economics, and there is no objective reason for conventional economics to exclude this part from the definition of economics. Including it in economics will make economics relevant to address problems like poverty, development, environment, etc. which currently stay excluded from economics despite that their roots lie in economic behavior. Its inclusion into economics distinguishes the economics in Islam from conventional economics and hence the need to call economics in Islam as Islamic economics.

To understand economics in Islamic perspective, it is therefore important to understand how beyond market segment of an Islamic economy works and what is economics rather than to understand how to introduce the futile exercise of conducting Islamic banking and finance within interest-based financial system. Economies, like Pakistan, that made serious efforts in making its economy Islamic would have gained considerable mileage if it had started the process by including the beyond market segment as defined above in its macroeconomic framework. Incorporating beyond market segment of the economy in its macroeconomic framework can help the economy achieve its targets of growth and equity simultaneously.

The repeated failures of macroeconomic policies based on conventional framework of macroeconomic model, the latest one being 2008 crises, have finally made conventional economics realize that neglecting the economics beyond market is not good economics.¹⁷

Appendix II: Macroeconomic Objectives of an Islamic Economy

Full employment is one of the key macroeconomic objectives in conventional economics. The current unemployment rates in some major Muslim countries and in some developed countries do not qualify them as meaningful macroeconomic objective even for so-called “developed” economies. Unemployment rate is believed to indicate the health of an economy. The current unemployment rates ranging between 5% and 8% in almost all major Muslim economies do not really indicate the health of the economy. Full employment is considered a solution for the improvement of health in the economy problem but in what sense? Full employment does not even mean eradication of poverty. Instead, it often forces people to remain in poverty.

We do not find any reference in the Quran and Sunnah about unemployment or the objective of ensuring full employment in the economy. What we find are the injunctions for feeding the Masakeen and giving support to economically less privileged members of the society.¹⁸ Conventional economics would consider such injunctions outside the realm of economics and would consider injunctions for feeding or supporting poor as free lunch, creating beggars and free riders. Conventional economics would rather suggest creating jobs for poor in an economy. This is what Professor Yunus, a Nobel Prize Laureate from Bangladesh and a founder of Grameen Bank, hinted at in a lecture delivered in Islamic Development Bank while referring to Zakah and Sadaqat injunctions in Islam. According to conventional economics, the focus of the economy at macro level is “output growth with full employment.” What would be the focus of Islamic economy at macro level? “Growth with ‘what’, if not full employment?”

There is no direct reference in the Quran and Hadith with respect to growth and full employment in the economy, which are considered two topmost macroeconomic goals in conventional economics. Growth did not need a reference. Once instinct of self-interest has been recognized, the sanctity of private property rights has been secured, rules for exploitation-free market laid down, and then it goes without saying that the system would make “growth” to take care of itself. However, it is very much evident that the Quran and Hadith require taking care of Maskanah (an Islamic term for poverty) of Masakeen (the Islamic term for poor). Masakeen can be interpreted as the people who are unable to meet their minimum living needs from the market and look toward help from beyond market.

Islam makes it the responsibility of every individual in the society to take care of the Masakeen around beyond market. Twenty-two verses (261–282) toward the end of Chap. 2 and many other verses in the Quran emphasize giving away to needy, deprived, and less privileged members of the society. Feeding the Masakeen is a top priority item in giving away as is evident from the Quranic references mentioned above.

The macroeconomic objective in an Islamic economy, therefore, needs to be specified about poor and poverty (Faqr and Maskanah, in Islamic terminology) and not in reference to full employment or unemployment. “Growth free of Maskanah” instead of “Growth with Full Employment” will be a more relevant macroeconomic objective from the Islamic perspective. No doubt, it may be hard to visualize that there would be zero Maskanah or there will be no Masakeen at any point of time in any society, but we can objectively fix a natural rate of Maskanah in the society for declaring the society free of Maskanah. We may assume, for example, that the incidence of up to 5% Maskanah may be considered as if there is no Maskanah in the society. This 5% of incidence of Maskanah may be reflecting the number of people suffering from various permanent physical and mental disabilities, making it impossible for them to make their livelihood from the market.

In view of this reality, we can therefore declare an economy as free of Maskanah if the incidence of Maskanah is below a natural rate of Maskanah. This is like saying “An economy is at full employment when the unemployment rate is below a certain level of natural unemployment rate.” The natural rate of Maskanah can be determined objectively, through household surveys, labor force surveys, and censuses. This makes the macroeconomic model of the economy similar to Classical macroeconomic model with the exception that while Classical macroeconomic model looks at “Output at Full Employment Level,” the Islamic economy looks at “Poverty-Free Output level” (poverty in Islamic terminology referring to Maskanah).