4(c) Monetary Policy: An Overview

It is widely felt that in an Islamic economy monetary policy should pursue the goal of maintaining “stability in the value of money, economic well-being full employment and optimum economic growth and promotion of distributive justice”. It is thus widely believed that the central banking system in an Islamic state must control the supply of money and money supply be adjusted to the need of the economy in terms of both short term stability, long term growth and allocation of bank resources to help realise the goal of social welfare.
Thus despite the abolition of interest rate and non-availability of open market policy a number of monetary policy instruments such as cash reserve ratio, liquidity ratio, credit ceilings, “profit-sharing ratio” indifferent sector financing and moral suasion can be legitimately used in an Islamic economy as components of stabilisation, distribution and growth policy. Besides, due to its effects on international capital movements, monetary policy will have a special advantage in securing balance of payment equilibrium.
As regards power to create credit by commercial banks, there exist some controversies. But the predominant view is that commercial banks should have the power to create credit provided its benefit does not go only to big business firms controlled by a family or a group of inter-locking directorates of firms or banks to the neglect of the larger interest of the society. This has crucial policy implications particularly in the case of poor Muslim countries where conscious policy measures are to be taken by the central bank to bring about a more equitable distribution and allocation of the bank resources (in the form of rural credit) to help financing the agriculture sector, rural development, and agro based industries so that benefits go to rural areas, where bulk of the people live in most of the Muslim countries today.
As noted earlier, that Islamic economy, being essentially equity based rather than loan based, the ideal alternatives to interest are profit and loss sharing and Qard-Hasan in production and consumption areas respectively.

Policy Mix

An Islamic economy does provide a scope for securing a policy mix of monetary and fiscal policies which will permit to achieve more objectives than would be possible with the use of one policy instrument alone.