Munich Personal RePEc Archive

Islamic monetary policy: Is there an alternative of interest rate?

Uddin, Md Akther and Halim, Asyraf (2015): Islamic monetary policy: Is there an alternative of interest rate?


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At the advent of global financial crisis conventional monetary policy has failed to regulate the money market and the consequence of which was seen in the global financial and capital market. This paper takes an attempt to give a brief outline of how Islamic monetary policy can be a sustainable alternative to the conventional. In order to understand Islamic monetary policy better we went back to early Islamic period and discussed how money was evolved and monetary policy was performed at that time. Reemergence of Islamic economic system in the latter half of the last century encouraged scholars in this field to have a fresh look at this issue. Comparative analysis shows that Islamic monetary policy can adopt many conventional instruments which are in line with the Shariah guidance such as: Legal Reserve Ratio, Credit Rationing, Selective credit control, Issue of directive, and Moral suasion etc. As interest rate, the key tool of conventional monetary policy regulation, is prohibited in Islamic economic system, the need for sustainable alternative is the order of the day. Unfortunately, Islamic banks and financial institutions set their benchmark based on London Interbank Offered Rate (LIBOR) which raises doubt and controversy of the uniqueness of Islamic finance. Literature shows that this a growing field of knowledge and many theoretical works have been conducted in this area but little empirical work, moreover, very few on alternative benchmark for Islamic economic system. By analyzing literature we propose in our study that GDP growth rate adjusted for inflation can be set as a benchmark for money market instrument and reference for financial and capital market as we argue GDP growth rates reflect real balanced growth potential of an economy as it is correlated with national income, savings, inflation, exchange rate and investment compare to real interest rate, which is fixed in the money market and does not take into account the real sector.

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