Monetary Policy In Islam

Topics: Monetary policy, Fractional-reserve banking, Money supply Pages: 7 (2859 words) Published: April 16, 2015
Monetary Policy in Islam
Introduction
Consistent with the Islamic ideals of social justice, equity, fairness and balance, there are three major objectives of monetary policy in an Islamic economy which discards interest. These objectives are a) Stability in the value of money;

b) Economic well-being with full employment and optimum rate of economic growth

c) Distributive justice.

For a proper appreciation of the above-mentioned objectives of monetary policy and how these may be realized, these are explained below:

1. Stability in the Value of Money
In an Islamic economy it is almost mandatory on the central bank to preserve the value of money. Thus the central bank should allow expansion of money supply to the extent it is justified by a possible contribution to growth in real terms. The stability in the value of money should be accorded high priority because of the unequivocal stress of Islam on honesty and fairness in all human dealings, and because of the negative impact of inflation on socio-economic justice and general welfare. But, rather than absolute, this objective would mean relative stability in the general price level. Absolute price stability is neither feasible nor desirable as it may conflict with the optimum growth and full employment objective of the monetary policy.

1.1 Economic Growth and Employment

While inflation is incompatible with the goals of an Islamic economy, prolonged recession and unemployment that cause human sufferings are also unacceptable. Monetary policy has, therefore, to aim at a high rate of economic growth with full employment and utilization of productive resources. However, maximization of economic growth and at all costs is not the objective of monetary policy in an Islamic economy. Material prosperity is to be attained within the framework of Islamic values. It should not be attained through the production of morally questionable goods and services. It should not lead to an excessive and overly rapid use of Allah-given resources at the expense of future generations, and it should not be harmful to present or future generations by degenerating the moral and physical environment. Environmental degeneration with degradation and depletion of land, water and forest resources and serious air and water pollution are already matters of great concern around the world. Hence, the concept of “sustainable development" means meeting the needs of the present generation without compromising the needs of future generations. Economic development and sound environmental management are complementary aspects of the same agenda. Without adequate environmental protection, development will be under mined; without development, environmental protection will fail.

2 Distributive Justice

Monetary policy in an Islamic economy should be used actively to promote the goal of distributive justice and prevent concentration of wealth and economic power. However, too much concern with distributive justice in formulating and implementing monetary policy may adversely affect its overall efficiency and effectiveness in attaining the other goals of monetary policy, e.g., growth, employment and development. Reduction in income inequalities and necessary redistribution should be an important policy objective of an Islamic state and hence the domain, mainly, of its fiscal policy. Monetary policy can contribute to this objective.

3 Functions of the Central Bank 

The central bank should be the pivot of the Islamic Banking System, because only through its conscientious and creative efforts and eternal vigilance can the Islamic money and banking system function properly and achieve its objectives. It should be an autonomous government institution responsible for the realization of the socio-economic goals of the Islamic economy in the bubble of money and banking. Like all central banks, the central bank in an Islamic economy should be responsible for the issue of currency and, in...
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