THE NATURE OF MONEY AND MONETARY POLICY islamic economic.doc

8/8/2019 THE NATURE OF MONEY AND MONETARY POLICY islamic economic.doc

1/26

THE NATURE OF MONEY AND MONETARY POLICY

FOR ISLAMIC ECONOMIC INTEGRATION

Money, capital markets, financing instruments and the economy related to real sectoral

activities (i.e. productivity in a social and economic sense) are not detached phenomenain the study of social well-being with complementarity among the relational variables.

Such a social well-being function is based on the cause and effect of the totality of

interrelationships among the entities mentioned in this chapter and more. Hence if thisinteractive view on a relational order is to be accepted then one is led to inuire first into

the nature of money and its relationship with real economic activities.

!he uestions before us are the following"

#o e$isting theories and the nature of money therein establish a cause and effect

(i.e. causal interrelationships) between money, capital markets, financing instruments andreal sectoral activities, all factors that together define the social well-being function% &an

such interrelationships be at all possible with the e$isting theory and nature of money%

How is an alternative conception of money derived in relation to the social well-

being function that in essence describes the causal and complementary interrelationshipsamong money, financing and real sectoral activities as a subset of a greater range of

socio-economic activities%

'hat are the institutional and policy implications of the two conceptions of

money and their relevance to the Muslim 'orld towards establishing an ummaticglobaliation in the new millennium%

Objective

ur ob*ective in this chapter is to answer the above uestions in an analytical

framework and thus to bring out the ineluctable note that the epistemological foundationsof the +slamic worldview allows only endogenous money to prevail and have meaning.

Such a meaning of money brings out the causal interrelationships in an +slamic social

well-being function. 'hile investigating this premise we will show that the conception of endogenous money is functionally different from both the e$ogenous nature of money in

received framework of macroeconomic theory and from the perceived nature of

endogenous money in other models of money and the real economy. !he policy and

institutional ramifications within a globaliation process with integrated capital markets,

factor markets and product markets are then derived.


2/26

A review of litert!re

+n recent times, the usual writings by +slamic economists on money have been

primarily in the following areas"

neoclassical idea of money in utility functions with issues of moral haard and

+slamic ideas of risk aversion has been thoroughly used. !he mudarabah (profit-

sharing)-musharakah (euity participation) contracts are then studied in the

background of such a neoclassical economic approach (han, /01).

further development of the above neoclassical perspective on liuidity

preference theory against the background of +slamic values is the !obin-2rainard

-theory of resource allocation. !his has been used to study money with (!obin 3

2rainard, /405 han 3 Mirakhor, /0/) or without international trade in the

model of money and economy (6aidi 3 Mirakhor, //).

!hen there is the usual study of money as a eynesian entity. Such studies have

used the well-known static eynesian models of +S-7M and of spending-multiplier relations (&hapra, //45 &houdhury, /0/a).

Neoclassical treatment of money and goods (real sectoral activities = economic core)

'ith regards to the neoclassical economic conception of money in the utility

function it is clear that the epistemological uestion of interaction and complementarity

(integration) between money and goods is ignored in the marginal substitution theory.

Money now is treated as an asset worthy of acuisition as a substitute for goods.

#etermination of the marginal rate of substitution and of marginal utility of

money in such neoclassical utility functions thereby implies the e$istence of a price for

money relative to prices of its substitutes, goods. !his very implication, without whichthe resource allocation problem using money cannot be meaningful in the neoclassical

economic framework, brings about the ineluctable need for a price of money, which is the

rate of interest. +t also ineluctably assumes that such a preference remains embedded inhuman behavior, and as such, within institutional behavior at large. +ndeed, neoclassicism

(beyond being simply restricted to economics) manifests the hegemony of eualiation of

technological change and technology transfers. !hese carry with them the concomitant

utilitarian values and specific kinds of institutions across trading nations that create theharmoniation of technology according to the neoclassical economic theory of factor

price eualiation.

'hile we increasingly watch the above vases to be the evolving pattern of structural change in today8s capitalist globaliation, the following uestion remains" 9ven


3/26

in the specter of global capitalism with managerial finance, why is a large part of

humanity being marginalied to poverty, financial bankruptcy, uncertainty and

unbalanced economic growth% 'hy is it that the last two hundred and fifty years of teaching and practicing neoclassical economics in classrooms and bringing it up on the

drawing boards of the national and global institutions, have not reduced the cost of

technology, the uncertainties and the social costs% !hese uestions enter utilitariananalysis and render the perception of neoclassical economics with money as an asset in it,

as being totally contrary to the issues of complementarity, coe$istence and social balance.

different conception of money is therefore needed to replace the neoclassicalmarginalist relationship between money and goods.

!he utility-based conception on money describes a model of money and its

relationship with resource allocation in the framework of steady-state euilibrium.

&onseuently, ethical values, laws and policy decisions that simulate the rules affectingethical and moral development, cannot remain sensitive in these regimes of optimal

states. :references on choices that entered the utilitarian values in the first place, are seen

as optimal, unchanging, and e$ogenous. n e$ternal hegemonic rule has, as if,automatically regulates human preferences toward accepting the e$ternally determined

datum of certain given values. !hey are based on neoclassical substitution, optimality and

euilibrium, each reinforcing the other ones. Shackle calls this human unrealism as the

impossibility of describing creative ;novelty8 in models of the neoclassical genre(Shackle, /-theory of money is also a re-formulation of its older version called liuidity preference theory of money (!obin, /10). +n both of these cases we find that the

discount factor for capitaliing an intertemporal allocation of money in resources is the

central issue.

=ote then the following brief formulation" 'e contend that the problem with -theory of money in shari’ah arises from the notion of discounting present in -theory

(and in general with the entire idea of intertemporal discounting in resource allocation) .

!his is an old debate among +slamic economists (6ara, /0?). !o bring out the bone of contention against acceptance of -theory and the discounting methodology, let us first


4/26

innocently denote the discount rate by @r@ (and not with @i@ A interest rate) as our assumed

mudarabah-musharakah based rate of return or a weighted average of profit-sharing

rates. 'hat does such a methodology mean in the +slamic concept of resource allocation%

#iscounting is a dynamic version of marginal rate of substitution between saving

and consumption. n +slamic economist may argue that the saving can be in profit-sharing outlets. !his may be true. 2ut the fact remains unchanged. !he transfer of

resources intertemporally means that the money capital has been held up today in awithdrawal called savings in macroeconomics. Hence this amount could not have entered

the cycle of spending. Spending on the other hand, brings about immediate financial

rewards in the form of personal and corporate ta$-reductions, economic growth,increased incomes through employment and inter-corporate profitability, reduction in

government deficits and the conseuential price stability with higher real values of

earnings. 9ach of these social returns enhances socio-economic security at the currenttime.

=ow why would a person, business, institution and government hope to wait for an economic return until a deferred moment in time% !he argument can be made that

some returns from ventures appear after a gestation period, whereas the social benefitsappear continuously from the moment spending is made. n the deferred component of

economic returns from investment, the nature and meaning of the rate of return is

important to understand. +s this a guaranteed rate or a probabilistically e$pected rate inthe future% Shari’ah re*ects accepting a fi$ed rate for asset valuation, whereas the

probabilistic nature of the rate makes it a gamble in the future. +n the latter case, shari’ah

prohibits undue and indeterminate risk to shareholders.

:robabilistic rates defy measurement due to the appearance of contingencies.

'hat economists have done in such a case is to assume given probability distributions for the rates and returns. Such is the case with the risk-aversion theory and the adaptive

Markovian models of random variables that +slamic economists have accepted asmethods while being oblivious of the +slamic uestions underlying resource allocation

involving discounting (&houdhury, //Bb). +ndeed, +mam Chaali held the view that

even the economic laws of demand and supply do not describe the real movements of

prices, which he linked with acts of llah. +n probabilistic rates too we find the sameimpossibility of their precise measurement in the future (+slahi, //1).

7et us go on in the arguments. Money cannot e$ist in the future if transactions are

not well determined then. +n this case only probabilistic rates are assumed to e$ist over

time. !his leads to economic speculation. !hereby, money cannot be held intertemporallyin the absence of known rates in the future. !hus in the end, our innocent looking @r@ has

become nothing different than the rate ;i8, a price for waiting due to financial speculation

on future returns. Such a rate can be nothing other than the rates of interest (riba).

!he verses of the Qur’an that support our arguments here are many (Qur’anB4"0?, 11"


5/26

possessions not become a circuit of wealth among the rich5 that the absence of circulation

of money reduces its real worth.

!he following saying of prophet Muhammad (hadith) speaks elouently on themeaning of valuation that must be associated with currently transacted things against

those that are intertemporally distributed"

9$change of gold for gold is riba unless it is done on the spot in eual uantities5

e$change of silver for silver is riba unless it is done on the spot and in eualuantities5 e$change of wheat with wheat is riba unless it is done on the spot in

eual uantities5 e$change of dates with dates is riba unless it done on the spot in

eual uantities5 e$change of salt with salt is riba unless it is done on the spot ineual uantities.

s in the time-value of money intertemporally, we would be trading current

money for money at each point of time in the future. !hat would be riba. +n other cases,

such as for the real estate mortgage (businesses, hence basic needs A salt, dates etc. in theabove saying), we would be trading money today for the money value of the physical

asset in the future. +n all such cases money must be transacted through real economic

activities, e$cept in the case of a barter economy (counter trade). +ntertemporal

transaction of money for money inevitably appears. !his is a riba rule of transactions.nce again therefore, the innocently looking @r@ as a discount rate of the neoclassical

economic genre and the -theory alike is nothing but the abominable @i@ -- the rate of

interest.

+ have not gone into further details here to discuss the analytical problems

associated with discount pricing and with the conceptions of optimality and marginal

substitution underlying all these when studied in the light of contrasting views. !hecontrasting views are of complementarity, diversity and knowledge-induced evolutionarydiscourses that are linked with the endogenous preference formation of the +slamic order.

2ut the keen reader may sense this from my earlier criticism of the problem of e$ogenous

preferences, optimality and marginal substitution in neoclassical economic theory. llthese are re*ected in the conte$t of the essential epistemology of universal

complementarity, interconnectedness, discourse and knowledge-centered evolution

presented in the Qur’an (?"?-E, E"BE-B


6/26

Feturning now to -theory, we find that there is no way in it of e$plaining the

interrelationships between money and real economic activities by replacing the

discounting method. Hence interest rate and future speculative transactions remainendemic in such a method of asset valuation. Gurthermore, the neutrality of ethics due to

e$ogenous preferences together with the marginalist independence among variables and

relations in the neoclassical economic trade-off render the -theory and all similar approaches towards e$plaining the relationships between money and real economic

activities untenable to +slamic ways of understanding the endogenously ethical money-

economy linkages.


7/26

eynesian treatment of money and economy in Islamic economics! predicaments

+n my opinion much has gone wrong with +slamic economics through writings

that adapted one or the other forms of eynesian e$pressions involving money. Such problems can be seen to arise from all ends money demand and supply, the valuation

of assets and asset pricing and the eynesian general euilibrium model.

+n the +slamic economic literature the rate of profit is found to be mechanistically

introduced in the demand and supply functions without incorporating in these functionsseveral important factors as follows" 'hat are the behavioural attributes (preferences) of

those who supply money (central banks, commercial banks and high fiat pseudo money)

and those who hold money (households, businesses and governments). +n +slamic societysuch preference behaviour is generated through +slamic values. +n the field of money,

such preference behaviour is applied to the conception and purpose of holding money and

institutional rules towards money and social well-being. Such a web of relations betweenmoney and socio-economic activities, that enter the social well-being function as

complementary ones is realied by an interactive process involving the agencies

mentioned above. Such interactive processes are based on shari’ah rules that bring about

issues of ethical values, money and real economic activities to bear upon a consensualdevelopment of the rules and policies (ahkam). !hese ahkam as-shari’ah are temporally

discoursed, and thereby reinforced, revised and improved. !his is the nature of

institutional decision-making and learning process that mark the interactive (i"tihadi),integrative (i"ma) and evolutionary (khal#-in-"adid ) processes relating to money, +slamic

preference formation and their combined functional relationship with real economic

activities. 2ecause of the evolution of preferences in such a knowledge-induced process

of interaction, integration and creative evolution (++9-world view), such preferences aresensitied by the continuous formation of knowledge in such an order. !hey are therefore

termed as endogenous preferences.

9ndogenous preference formation in +slam is caused by various kinds of shari’ah- based financial instruments. mong these are security of returns, fairness of contracts and

distribution, appropriate venues of spending and participatory enterprises that arise with

the elimination of interest-based financing, frivolous and speculative ventures. longwith these, several other socio-economic prerogatives must also be taken up. mong

them importantly are, risk-management by appropriate product and risk diversification

through increasingly participatory co-operative *oint ventures.

!he profit-sharing ratios to be fair and empowering to both the asset-holders andthe initially asset-less at the grassroots must be re-contracted as wealth and resources

increase in the hands of the once asset-less. !he participants in co-operative *oint

ventures must be made aware of the stability and security to be gained amidst dynamic basic needs regimes of change. !his is a process in knowledge formation through

discourse and pro*ect identification with tradability of both goods and services (skills,

appropriate technology) among the participants.


8/26

&onseuently, the problem of economic stability cannot be an automatic

assumption in the models of money taken up in the eynesian framework in +slamic

economics. !he problem of stability reuires the study of linkages among socio-economic variables, their relations and agents. !his is bound to be a study in the

framework of knowledge forming processes as e$plained by the ++9-methodology.

!hereby, the demand and supply of money are determined by endogenous preferences in+slamic political economy. 7ikewise, through the endogenous nature of money demand

and supply we can study the problems of product and risk diversification that are reuired

to engender security, fairness and enhanced participation in the economy-wide sense.

!he idea of productive mobiliation of resources in the eynesian spending-income model is also a misnomer for use in +slamic economics. Gor e$ample, the notion

of full-employment output and resource mobiliation in eynesian general euilibrium

model is fraught with many problems of instability and impossibility of attaining full-employment euilibrium. Gor instance, application of rational e$pectations hypothesis

applied along the eynesian aggregate supply curve shows that the general euilibrium

point at the full-employment level is both an elusive and a highly charged point caused bye$pected price increase.

!herefore, the money demand and supply functions that determine the monetary

sector euilibrium no matter in which system, +slamic or eynesian, must respectively

include the social and economic forces that underlie the general euilibrium pointdetermined by the aggregate demand and supply relations. !he position of the aggregate

demand curve will e$plain how a given supply of money is held, i.e. in liuidity or in

assets (Hall 3 !aylor, /04)%

"!e#tio$ of #vi$% i$ &e'$e#i$ $( I#l)ic eco$o)ic#

!he uestion of saving against spending appears as a serious debility of the+slamic models of eynesian genre. eynes himself did not encourage savings. He

viewed it as a withdrawal from the level of economic activity. He held the view that full-

employment euilibrium could be established only by fully mobiliing savings into allforms of Iproductive8 spending. Jet the property of the eynesian money demand

function does not speak the same truth. !he unproductive nature of spending re-enters the

money demand function with the appearance of interest rates in the precautionary andspeculative demand functions. +n the latter case it causes mobiliation of resources into

speculative assets. +slamic economists seem to have forgotten this fact. &onseuently,

financial instruments such as bonds and derivatives have become popular among +slamic

financial institutions, which have been put in a race to compete for portfolio savings. Seefor e$ample the derivative issues of Gaisal Ginance in Switerland. 2ased on bond-

transactions, open market operations as monetary policies have been legitimated in

+slamic economics (&houdhry 3 Mirakhor //


9/26

!he Qur’an never for once has emphasied saving against spending in the good

cause. ne can read the profuse number of verses in the &hapter on Heifer ( $akarah) on

this matter % !he lesson of spending is that an +slamic economy must be formed and progressed on the basis of possibilities generated by product and risk diversification and

by e$tensive inter-sectoral and inter-agent participation. Socio-economic development

would then mean the attainment of socio-economic sustainability realied by dynamic basic needs regimes of change. !his is how growth menus, employment, technology,

markets and institutions will all be carried forward in tandem with each other. Here the

causal interrelationship between spending and real sectoral activities, as against saving, isdetermined by treating money in circulation. 'hen the contrary happens then money

becomes a saving category (MB). 'ith this the rate of interest enters as a return on

savings. 'ithdrawal increases and resource mobiliation is deterred.

+n the end therefore, a eynesian treatment of money in +slamic economics isneither rich nor e$planatory of the essential meaning revolving around the Qur’anic

worldview of ;paired8 complementarity, inter-linkages, discourse and knowledge

formation, and mobiliation of resources for realiing social well-being. +ssues relating to bond financing, cost of capital, valuation and asset pricing, the resulting effects of these

on the +slamic ideas of financing and resource mobiliation have all remained unhealthy

perspectives (Mirakhor //4, ahf //


10/26

n the matter of money in +slam the same causal interrelationship between money

and real sectoral activities is to be e$plained in view of the social well-being function that

simulates interrelationships in the knowledge-induced framework of the complementingentities (&houdhury //0d). Money is thereby not an e$ogenous factor in economic

activities. 7ikewise, the real sectoral activities are not independent of money.

simple e$planation relating to price, output, uantity of money and preferences

can be made here. Households have preferences for holding money first for purchasingdynamic forms of basic needs and comforts. !hese are +mam Shatibi8s refinements

(dhururiyath ha"iyyath tahsiniyyath). Secondly, money is used for earning stable and

secured yields from spending it in the good things of life. 9$amples here are of profitsand returns from +slamically productive investments5 in government financing to enable

the formation and simulation of knowledge-flows among participants, that in turn can

provide essential services, such as, monetary control, security, and defense. &entral banksare induced to control currency circulation as endogenous money and to monitor relevant

policy and departments conducive of this realiation. 'e note that in each of these

agencies the role of a unifying process of knowledge formation is essential. Such is theinteractive, integrative and dynamically evolutionary process of knowledge induction

relating to socio-economic variables and their interrelations. !he resulting interactive

preferences then determine the rules and inferences from shari'ah (ahkam as-shari’ah).

!hey thereby, link the socio-economic variables with money in the light of theknowledge-values.

'ith the continuous introduction of knowledge-flows, a uantity of money as

currency enters the economy in response to the categories of activities as mentioned

above. +n turn, as this volume of currency mobilies resources and increases participationand linkages in the economy, the productive strength of money is enhanced in turn. !his

kind of a causal interrelationship between money and real sectoral activities alters the picture presented by the controversial M-&-M cycle regarding which both the classicaleconomists and Mar$ wrote (Heilbroner, /01). +n the +slamic cycle of causal

interrelationship it is the prevalence of ta&hidi episteme that causes unifying knowledge-

flows to arise within the complementarity framework of these causal interrelationships.!he guidance to realie these complementary rules from the essence of unity in +slamic

world-system is provided by the way of shari’ah instruments linking money with real

sectoral values. Hence, by the central presence of knowledge at every new emanation of causal interrelationships the ++9-worldview overcomes the problem of random circularity

as reflected in Mar$@s M-&-M cycle (&archedi, //).

'ith the introduction of endogenous money in +slam, the meaning of demand and

supply of money disappears. !hat is because neither central banks nor financialintermediaries can create money e$ogenously. 9$ogenous money e$ists in the form of

promissory notes created by commercial banks with statutory reserves. +n the endogenous

monetary system a uantity of money enters economic activity in response to thefinancing of real sectoral activities. Money flow thereafter changes in volumes through


11/26

recursive interrelationships with the level of economic activity. =ow as economic activity

increases, an e$tra uantity of money is released. Subseuently, this increased uantity of

money enhances more of the activities, and the banks respond. !he nature of loantransactions by commercial bank is determined by discourse among the clients, the bank

and the monetary authorities on the appropriateness of the activities for financing. Such a

discourse rather than being cumbersome, can be regulated by means of manualsdeveloped through the e$perience of discourse among agents. !hey are the result of

evolving perspectives on ahkam as-shari’ah governing the endogenous causal

interrelationships between money and real sectoral activities with the social well-being inmind.


12/26

=ow the resulting money function, M, can be e$pressed as,

M A M* + ,* -+P* --K∩:rL, (1.)

where, denotes the vector of knowledge-values. !hese are ordinal assignment in

response to the effectiveness of the ++9-process through an evaluation of the elements of

the vector-valued ,* - in the perspectives of the application and benefits of ahkam as-

shari’ah in the socio-economic order. +n this way, ,* - denotes the knowledge-induced

vector of socio-economic variables influenced by the -values. P* - denotes the

knowledge-induced policy variables influenced by the -values. ∩:r denotes the

resulting interactive knowledge-forming preference formed in the ++9-process of discourse and leading to consensus (integration) (&houdhury, //Bc).

!here is a difference now between the above form of money function and the

euation of e$change in the uantity theory of money. +n endogenous money in +slam it is

the primacy of prices that determines the uantity of money and not vice-versa, asotherwise is the case with the uantity theory of money. +t is also the indeterminacy

between the money flow and price level that leaves the uantity theory always

uestionable and the relationship unstable in an environment of inflation (7aidler, /0/).

=e$t we e$amine how the vector of prices .* - in terms of the vector of output,

,* -, is related to M, keeping in mind the framework of the ++9-world view on which

these causal interrelationships are derived% !he primacy of -values in the ++9-process of

discourse monitors the target of near euality between the rate of growth of output and

money. !his would cause inflationary disturbances to be controlled accordingly. =e$t, theconcept of stability between money, output and prices being that of maintaining

sustainability of the relationship between the rates of change of these variables, the

relationship, gM(

) A g(

), will be monitored within the ++9-process of knowledge

formation. Here let ( ) denote an interactive aggregation of the elements of ,* -

(lein, /E4). 7ikewise, p( ) will denote the corresponding interactive aggregation of

prices. Such geometric forms of aggregation are reuired due to the e$tensive

complementarity and diversity of possibilities in the +slamic domain. !his determines the

necessary and sufficient conditions for the endogeneity in the causal interrelationships

between money and real sectoral activities. =ow since the endogenous process impliesthe epistemological background of ta&hidi unity and the derived unification of

knowledge signifies the derivation of shari’ah rules ahkam as-shari’ah, therefore we canwrite, / 0 ∈ Ω (ta&hidi &omplete nowledge) (&houdhury, //1).

Grom the above-mentioned money function we now derive the causal

interrelationships between money and real sectoral activities that recursively feed into the

ob*ective simulative criterion of the social well-being function, '(.), over / 0-values. Gor

simplicity, we will reduce knowledge-flow to a uniue consensual value, θ, governing all


13/26

variables during a range of interaction. 'e will also identify interaction with knowledge

formation processes, and thus pro$y K∩:rL by the same uniuely consensual θ-value. 'e

now write,

M A M*θ+ ,*θ-+P*θ--,

(1.B)

as the money function in the complementary knowledge-induced variables.

!he ob*ective simulative criterion of the social well-being function is given by,

SimulateNθO '(M+ ,+ P-KθL, (1.?)

the simulation being over rounds of the ++9-processes of discourse leading to

consensus and further evolution of the same.

!he recursive relations are,

MA f (M+ ,+ P1 '-KθL (1.E)

6 A f i(yi1 '-KθL, (1.1)

where, 6 denotes the variables, (M, ,+ P)KθL taken alternatively in circular

seuence. yi thus denotes the tuplet out of the triplet shown, by supressing the

dependent variable each time. +n any given cycle of recursion, a lagged value of

' is given.

'e now have the following directions of causal interrelationships"

with θ∈Ω, f((,+ P)KθL)→ M*,+P-KθL→ '(M+ ,+ P-KθL→ K=ew θL→ evolutionary

processes

(1.4)

ta&hidi episteme ------ ne ++9-process -----emergence of a subseuent ++9-process, etc.

ta&hidi episteme→

----ayaths in a’lamin (world-systems)-------→

culminating toΩ

.

Pnity A Ω→ unification of knowledge" world-system (money-economy)→culminating to

Ω.

Money as so formed endogenously and affecting all variables and the social well-

being through the endogenous process of knowledge simulation is the endogenous money

in +slam. long with it the socio-economic variables and the policy variables become


14/26

endogenous as well. Gor such endogenous transformations to occur the role of markets

becomes very important. !he role of government (state) then reduces to simply guiding

the formation of knowledge and directing choices to the shari’ah possibilities. !he state becomes a participant with the rest of the agents while it maintains control over limited

principal functions. !he derivation of causal interrelationships between money and goods

in the +slamic political economy being different from that of the relations of the uantitytheory of money, the theory of endogenous money in +slam is conseuently also different

from the mistaken caption of endogenous plastic money in the present days8 consumerist

society (#esai, /0/).


15/26

Polic' i##!e# wit2 e$(o%e$o!# )o$e' i$ I#l)

+n the system of endogenous money in +slam, it is necessary to convert the

monetary system to a DD per cent reserve reuirement. t first this appears to be no easymatter in the midst of today8s entrenchment of the monetary system based on promissory

notes found in the capitalist penetration of capital markets and macroeconomic policing.

Jet as we are today thinking on post-modernity of the twenty-first century, wherein newvistas of socio-scientific inuiries are opening up, such new and bold challenges toward

ummatic transformation must not be considered impossible. 2elow we provide some

policy issues that could help in the transformation of the monetary system in the Muslim'orld into a well-coordinated financial order with endogenous money in +slam.

$uilding up the ** per cent reserve re#uirement monetary system

Since the banking authority in endogenous monetary system would simply provide currency to commercial banks according to the demand for real sectoral spending

in goods and services, investments and social security, therefore, a one-period laggedvolume of bullion reuirement is to be maintained. !his will back up such a demand. 2ut

the &entral 2ank will keep an additional amount of currency in reserve without supplying

it to the economy. !he amount of currency to be provided to financial intermediarieswould be determined through discourse between the commercial banks, the &entral 2ank

and the private sector representatives. !he latter would come from consumer guilds,

investors, corporations, financial development planners etc. +n this way, the volume of currency to be created is brought in co-ordination with economic prospects. !hereby,

market friendly policy control on money, output and prices is maintained. !he result is

improvement in the +slamic social well-being. !his happens as e$tensivelycomplementary relations now generate participation, linkages, product and risk diversification. Grom these conditions economic growth, price stability and socio-

economic development are attained simultaneously -- not in a trade-off.

'ithin the present conventional banking system, the above kind of discoursed

creation of money could be possible. =ational development plans of Muslim countrieswould then incorporate in them a distinct and focused program for alleviating poverty

and promoting microenterprises at the grassroots (khtar, //


16/26

Micro3)o$etr' i##!e# for (evelo.)e$t fi$$ci$% wit2 %r##root# foc!#

Most accruals to the DD per cent reserves will arise from the financial returns

generated in specifically integrated markets. !hese markets would transact on the basis of +slamic financial instruments, goals and outlets. Here the principle of universal

complementarity and the conseuential product and risk diversification suggest that

microenterprises, +slamic financial intermediaries, the usual private sector andgovernments must all broaden out their *oint ventures on the +slamic front. +ndeed,

microenterprises can flourish during their early stages of development only by cautiously

growing within their own specific kinds of markets for goods, services and financialcapital. !he same kind of e$tension of +slamic participatory businesses would likewise

apply to the global scene through national networks.

Market friendly policies turn out to be endogenous. !hey reuire a minimum of

institutional policing, as the ++9-process of knowledge formation and its socio-economicinduction progressively generates knowledge and mobilies preferences toward

+slamiing the economy. Gor this to happen, foreign trade and trade financing should be

considered as important venues of *oint ventures by +slamic financial intermediaries

towards developing microenterprises and sectoral linkages. +n the Muslim world todaywith its wide resource diversity and abundance, the principle of complementarity would

work in increasing trade on specific goods and services. !he stability of money in the DD

per cent reserve reuirement system, the stability gained by risk diversification, the progressive knowledge induction in making agents aware of the benefits from social

well-being enhancement, would all result in an intensification of trade within the Muslim

'orld.

=ow with a resulting short supply of traded goods, as they will get ma$imallyused up within the Muslim 'orld, a residual ;e$cess demand8 in the outside world will

appear. !his will result in an improvement in terms of trade. 9$port revenues will

increase for the Muslim 'orld. !he resulting e$port revenues instead of being directed infinancing e$ternal debt today will be directed towards attaining social well-being. +n this

transformation process the attainment of real economic growth with distribution and

stability appear as complementary factors. !he socio-economic benefits would thus bedistributive, not skewed. !hese kinds of ethical transformation with strong material

benefits to be gained therefrom, are derived by moral suasion on accepting a DD per cent

reserve reuirement system, even though initially, the reserve will appear as a

differentiated monetary reserve specifically maintained at the &entral 2ank.

I).ort$ce of .rice #tbilit' i$ t2e 455 .er ce$t re#erve re6!ire)e$t )o$etr'

#'#te)

:rice stability that is to be gained from DD per cent reserve reuirement is an

important issue to study. !he choice of a standard numeraire would be primal. Sincemoney itself cannot serve as a numeraire in such a system, the alternative basket could be


17/26

a combination of gold and silver. !he numeraire can also be denoted by the value of a

basket of core basic needs (&houdhury, //Ba). !here is averaging and inde$ing reuired

in these kinds of numeraire selection. +ndeed, choices of such basic needs were practiced by the :rophet Muhammad. !he same practice was carried on for many years afterwards,

until the Mamluks devalued the #inar by replacing it with copper fulus. :rice instability,

indebtedness and fundamental diseuilibrium in the e$ternal sector then appeared(llouche, //E). !he same predicament happened to the !urkish 7ira when the 2ritish

Covernment of the time monetied the ttoman e$ternal debts with paper money. !oday

such a monetiation of debt is continuing on in terms of the appreciating P.S. dollar against other currencies. !his is causing massive currency devaluation on a global scale.

!he stability of DD per cent reserve reuirement monetary system is further

enhanced by maintaining the growth of the volume of currency in line with the growth of

demand for real goods and services. !he aggregate demand is now derived by aggregateoutput in terms of its non-linear aggregation, as mentioned earlier. 'ith such a balance,

total productivity can be preserved and inflation can be removed. 7ikewise, indebtedness

can be annulled and the average propensity to spend can be increased both domesticallyand by foreign investors. Goreign investors would have to strictly comply with the

shari’ah reuirements of non-speculative investment and transact in specifically

integrated markets outlets.

Mo$etr' vo!c2er# for 2ol(i$% e$(o%e$o!# )o$e' i$ 455 .er ce$t re#erve

re6!ire)e$t #'#te)

!he route to monetary stability starts from the time money is held in the form of

currency to the time it is spent in shari’ah approved outlets. ny delay in this respect

becomes a leakage, which is denoted by savings. bank client can be given a voucher

denominating his bank deposits. !he deposits at any time are instantly converted into DD per cent reserves with the central bank. nly a marginal amount is kept as cash-in-vault

to meet the instant liuidity demand. !he client can fractionally liuidate his voucher *ustas a check and claim his deposits proportionately on that basis. !here will be an

accompanying return that would have been generated in the pool of invested fund in

which that deposit was initially absorbed as soon as it was converted into DD per cent

reserve and allocated into approved spending outlets. !he client could re-deposit theunused money for the euivalent residual value of voucher.

!he effect of the voucher is like that of a treasury bill. =ow the &entral 2ank

instead of creating money supply sells bills that commercial banks hold. !his sterilies an

euivalent amount of money creation that could have been generated by an increase inforeign reserves (2rown 3 Hogendorn, //E). !he difference between endogenous

money vouchers and treasury bills is this. Since the specifically integrated markets for

goods and services that link up with DD per cent reserves in the +slamic framework tendto +slamie the political economy, shari’ah outlets must be well-determined. !he very

fact that this kind of spending establishes stability and socio-economic returns is instilled

as an incentive through moral suasion using the ++9- knowledge forming the processe$plained earlier.


18/26

Li6!i(ti$% o!t#t$(i$% forei%$ (ebt

=e$t we turn to the case of liuidating outstanding e$ternal loans. How are these

to be paid out as long as the interest-bearing payments contracts remain with foreigncreditors% !he answer is that an additional supply of currency to settle debts in the short

run must be serviced, while alternative instruments such as debt-euity swapping and

buy-back options can be adopted with foreign creditors to settle residual outstanding debt(rugman, /0/). +n course of time however, increasing +slamiation of the Muslim

'orld must focus upon participatory *oint ventures in co-operation among themselves.

Similar ones can be e$tended to other participants provided the shari’ah conditions of such ventures are preserved in the light of the causal interrelationships between money

and real sectoral activities.

!he above kinds of +slamic transition promoted around trade liberaliation,

monetary co-ordination and integrated markets in the Muslim 'orld is a market friendlyapproach toward monitoring a direct linkage between money and real economic

activities. !his kind of transformation establishes cause and effect between a DD per cent

reserve reuirement with high powered money, output, prices and all those socio-

economic variables that simulate the social well-being function. Money now finally becomes euivalent to a volume of currency created on demand and fractionally held

according to the liuidating nature of vouchers that back up spending.

ne can note that in all of the cases discussed above there is a sharp distinction between eynesian and neoclassical policies and the ones mentioned for endogenous

money in +slam. !he policies on creating targeted volumes of currency in accordance

with spending demand, moral suasion and specifically targeted market outlets with thegrassroots focus in development planning within which +slamic financial intermediariesare reuired to operate, implies the following" Money is never held either as a marginal

substitutes against goods or according to any of the motives enunciated by eynes and

!obin. !his is true even if we were to reduce the uantity of money to meet simplytransaction demand. !he difference lies in the causal relationship first, between money

and prices in view of the goods transacted prior to money being created5 secondly,

between the two when money simultaneously provides a valuation to the markete$change.

!here is no causality in +slamic political economy such as, money determining the

level of prices. !hat is because even as real sectoral activities determine the demand for

currencies as money and this determines the level of social well-being, the ne$t round of monetary e$pansion is determined by the introduction of a new level of knowledge

formation in the ++9-system. !his dynamics once again sets the desired relationship that

should e$ist between output, prices and fresh uantities of money. Money is thus simply acontravention for valuation without having any intrinsic value of its own. +t reflects the

value stored into it by market transactions.


19/26

Polic' co$cl!#io$

+n conclusion, we note that the abolition of interest-based transactions by means

of profit-sharing ventures of different kinds will reuire an e$tensively participatory political economy. +n such a venue, financial capital and integrated markets for goods and

services must become directly interlinked. nly non-speculative real sectoral activities

would be accepted. !hrough such a web of participatory worldview the whole range of productive activities is to be simultaneously realied. !hereby, stability of prices, stored-

value of money and yields can be secured. :articipation brings with it product and risk

diversification.

!he +slamic #evelopment bank has been promoting trade and development co-operation in its membership (+#2, //


20/26

ummatic transformation. Money so understood is called endogenous money in +slam

(&houdhury, //


21/26

!he politico-economic planning toward creating such endogenous money in +slam

and its supportive DD per cent reserve reuirement monetary system must become the

priority development financing ob*ective for the future +slamic world. !here is both socialwell-being to be attained as well as great methodological weight in this. Such a process

toward ummatic transformation is seen to be possible and feasible starting right now withthe e$isting monetary authorities. +n the new era of human development such a monetary

medium can transform the financial and monetary architecture into a global model of empowerment, stability and social well-being. !he +slamic values of well-being rise

above the e$isting disabling uncertainty and instability of the ineuitable world-system of

money, wealth, resources and goods.

!he reciprocity of trade between +slamic countries is essential for establishing a

common market and this can happen only through a proper use of +slamic financial

instruments for realiing inter-sectoral linkages among real sectoral activities and

commodity transformation. Gor this to happen +slamic countries cannot gain from the

e$isting monetary and financial policies that are steeped in interest rates. +nterest rate backed macroeconomic policies were shown in this chapter to be intrinsically unstable

and to deprive social well-being. +t is therefore, high time to think in terms of changingthe entire structure of interrelationships among money, financial instruments, trade and

development in ways that can look forward to a viable participatory economy in the years

ahead.

!he combination of sheer time-dependent and normatively ualified estimates of the trade and development variables between +slamic countries for gaining more

complementarity among themselves seems to run into a rigid bottleneck. !his is

particularly true with respect to the monetary policies of these countries (S9SF!&+&

/00).

!hus the discount rate monetary policy was actively pursued. !his made the

commercial banks to freely transact their e$cess reserves in any kind of assets that they

considered acceptable to them in view of sheer profitability of operations on the basis of interest charges. &ommercial banks thus gained independence in their portfolio selections

in recent times. !he contrary ob*ective of establishing a learning and guidance

relationship between the central bank and the commercial banks with the clientele presence in the decision-making process, a feature of the +slamic institutional knowledge-

inducing process, was non-e$istent. !he role of the policy of moral persuasion in view of

the learning e$perience of relating a stable uantity of money to real sector activities was

not a prime ob*ective. ne therefore finds that a disproportionately greater proportion of the central bank loans went to the industrial sector as opposed to the agricultural sector.

!his was despite the fact that all of the countries studied happen to be agricultural

countries.

Subseuent to such a policy of favouring the development of the industrial sector

disproportionately over the agricultural sector, led to the marginaliation of the

agricultural sector in these countries in recent times. !he result was also the e$ternal


22/26

sector diseuilibrium caused by the heavy indebtedness of the industrial sector relying on

imports.


23/26

+n terms of money markets, the financial institutions in Muslim countries

promoted open market transactions, although this is of recent e$perience. However, thelack of product, risk and economic diversification in the real sectoral activities did not

give stability to these capital markets. Here either the e$perience of developing stronglyrisk-diversified securitied markets does not e$ist. Covernments play an overly e$cessive

role in capital markets, thereby causing inefficient allocations by a lack of appropriateinstruments, policies and institutions for the mobiliation of private capital (rif, //1).

+n the e$ternal sector, the e$change rate stabiliation policy depended upon

maintaining a floating e$change rate despite the central banks8 intervention to maintain afair level of their domestic currencies. Here a lack of well-developed open market

operations, a heavy reliance on foreign direct investments recently characteried by the

flight of capital and high e$ternal debt outstanding caused by unbalanced industrialiing

policies, could not make currency stabiliation by monetary policies effective.

&onseuently, high central bank reserve ratios were enacted as monetary policy. !hisadversely affected the mobiliation of national savings into investments. !he alternative

rested upon borrowing abroad, reliance on foreign capital and development financingfrom donor agencies. !he resulting lower real productivity at home and its rescue by the

use of monetary reserves to stabilie the resulting e$change rate-volatility meant that the

real value of the currencies was not tenable in supporting e$port demand. #evaluationwas a freuent feature of these economies as a result.

!he normative institutional financial undertaking based on endogenous money in

+slam has been shown in this chapter as a viable alternative in establishing a viable level

of real productivity by linking monetary flows endogenously with real sectoral activities.

!he euities market, *oint ventures and participation both instrumentally as well asinstitutionally among the countries in making collective and co-ordinated decisions is the

way out. !his is how through appropriate linkages between the real sectoral activities intrade as the medium, a balanced trade and development regime can be established and

more effective +slamic economic integration thus attained. !his is the message imparted

by the real asset-backed money and +slamic financial inde$ introduced in this chapter.


24/26

Refere$ce#

khtar, M. F. //


25/26

&houdhury, M.. /0/a. Qn +slamic econometric model for Malaysia with policy conclusionR,

,ournal of conomic 2ooperation /mong Islamic 2ountries, D"B, pp. B?-1E.

#esai, M. Q9$ogenous and endogenous moneyR, in 9atwell, U. Milgate, M. 3 =ewman, :. eds.

Ne& +algrave! .oney, =ew Jork, =J" '.'. =orton.

Hall, F.9. 3 !aylor, F.9. /04. Q!obin8s and the rental price of capitalR, in their

.acroeconomics 0heory +erformance and +olicy, =ew Jork, =J" '.'. =orton, pp. B14-10.

Heilbroner, F. /01. Q!he ideology of capitalR, in his 0he Nature and 6ogic of 2apitalism, =ew

Jork, =J" '.'. =orton, pp. D


26/26

!obin, U. 3 2rainard, '.&. /40. Q:itfalls in financial model buildingR, /merican conomic

7evie&, ol. 10.

6aidi, +. 3 Mirakhor, . //. QStabiliation and growth in an open +slamic economyR, 7evie& of

Islamic conomy, "B.

6ara, M.. /0?. Qn +slamic perspective on the economics of discounting in pro*ect

evaluationR, in hmed, 6. +bal, M. 3 han, M.G. eds. 4iscal +olicy and 7esource /llocation in

Islam Ueddah, Saudi rabia" +nternational &entre for Fesearch in +slamic 9conomics 3

+slamabad, :akistan" +nstitute of :olicy nalysis, pp. BD?-?E.

Date post:	01-Jun-2018
Category:	Documents
Upload:	maratusshaliha
View:	219 times
Download:	0 times

THE NATURE OF MONEY AND MONETARY POLICY islamic economic.doc

Documents