An Interest Free Economic Model

Competitive and Perfect Markets Characteristics of Islamic Markets An Exchange and Two Sector Economy Intertemporal Behavior : Consumption,

Savings and Investment Capital Cost and Return Financial and Fiscal Policies The Implications of the Model

Perfect Competitive MarketO Free Entrance or ExitO Goods are HomogeneousO Market Information Is AccessibleO No Resource FixityO Prices Are Efficient

Complete Market Comprehensive Private and Public Property Rights Transferable Property Rights Exclusive Property Rights Secured Property Rights There Are Markets for Every Form and Condition

of Exchange First and Second Rules of Welfare Economics

Characteristics of Islamic Markets

1. Comprehensive property rights & value system

a. Multiple forms of private & public ownership & utilization rights

b. Ownership right is trust ship

2. Freedom of contract choice within Islamic value system

a. No Reba b. No Gharar غرر c. No worthless value creation

بالباطل المال اكل d. No harmful externality

ضرار ال و ضرر ال

Definition of Reba & Its Implication

• Loan of money or exchange of a commodity or debt for an extra value or service

• An alternative to sale, leasing, & joint venture contracts

• Formation of the loan market in the economy & legitimacy of earning interest income

• Prohibition of Reba is equivalent to elimination of loan market from the economy & illegitimacy of obtaining interest income

Definition of Gharar (غرر )& Its Implication

• Full specification of the quantity & quality of the commodity & its value or price in sales contracts

• No fraud or unrevealed defection in the product sold

• No misuse of information• Market transactions are transparent &

secure

No Worthless Activity ( اكلبالباطل (المال

• Supply of consumer & producer goods in the commodity market renders utility & value added, respectively

• Worthless products & services: Alcoholic drinks, gambling, debt based

assets & derivatives, pornography, bribery, cheating, unproductive intermediation (speculation), hoarding price fixing collusions ,(كنز)

No Harmful Activity( ضرر الضرار ال (و

• All consumption & production activities with negative externality are prohibited

• Pollution cost is internalized in the production cost of the firm

• Private & social costs tend to become equal

Characteristics of Islamic Financial Markets & Contracts• Both real & financial assets markets may

be formed; the latter fully represents the former

• Enforcement of Islamic contract rules renders a secure, transparent & competitive market environment

• Firms offer both fixed & variable rate of return products

• Risk averter consumers will purchase FRR assets : differed payments, installment sales, & hire purchase

• Risk lovers purchase VRR assets: profit loss sharing, Modaraba, Mosharaka

• Repeated transactions among consumers & producers will bring the asset market into the equilibrium

Envision An Exchange Economy with one type of Intertemporal Contract

Differed Payment; Baia moajal, or Nesia

A Perfect Competitive & Complete MarketAssume Price Efficiency

Intertemporal Commodity or Financial Asset Market

Assume

Justly

Distributed

Endowments

Among

Consumers

Excess Supply AgentsExcess Demand AgentsEquilibrium Spot Price PEquilibrium Future Price P’Equilibrium Market Rate of Return

P’/P = 1+ n Nesiah rate =n=(P’-P)/P

Consumption & Savings Over Time

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,

,

,

O ,

𝑦 1UU

𝐶 ′ 0

E

E

Saving Consumer

Demanding Consumer

C”

The Effect of Increase in n upon Consumption and Savings Decision

Goods or Assets Goods or

Assets

n Nesia rate

n Nesia rate

DS

O O

Goods or Assets

n Nesia rate

D

OQ*

n*

S

An Islamic Investment Model

SG

I

H

XW

y1

y0

A

A,y1

yo,IO

I

n

O

The Investment Function

Investment and Savings Functions

Q

n

D+ID

O

n1

n2

Q1Q2 Q*

I

S*S

n

II*=SO

EHK A B

KH=AB

(1+n)

=

( n,

…

,…,

Policy Implementation

Financial Policy

• Stimulating

• Contractionary

Fiscal policy

• Stimulating

• Contractionary

Implications of Eliminating Reba for the

Economy

Elimination of Loan Market

Extension and Deepening of Financial Markets

Implications of Eliminating the Loan Market

Nominal & Real Income are Proportionate

Cost of Capital is Determined Endogenously

Rapid Adjustment to External Shocks

Market Stability Achieved Saving Incentives Are

Maintained