Reemergence of Islamic Monetary Economics: A Review of Theory and Practice

This paper reviews important theoretical and empirical literatures on Islamic monetary economics. The reemergence of Islamic economics and finance in the twenty first century has motivated the issue. The prohibition of Riba has imposed challenges on Islamic economists to come up with the viable alternatives to achieve Islamic monetary policy goals. Equity based profit and loss sharing instruments have been proposed for conducting open market operations in an interest-free economy. Moreover, a number of conventional monetary instruments are still available: changes in reserve requirements, overall and selective controls on credit flows, changes in the monetary base through management of currency issue, and moral suasion. Theoretically, the Central Bank can achieve desired goals by manipulating money supply and profit-sharing ratios, also, the evidence from empirical literature suggests money demand tend to be more stable in an interest-free economy. Whether monetary transmission works through Islamic banking channel is yet controversial but the literature is growing. These findings are not surprising as majority Muslim countries lack sustainable and equitable economic growth; suffer from higher inflation and unemployment, little or no monetary freedom due to fixed exchange rate regime, shallow financial markets and strict capital control. A number of policy implications have been proposed.