Abstract The paper discusses the nature of money in an Islamic economy and determines its value (exchange rate). The determinants of the demand for and the supply of money from an Islamic perspective are first discussed. Money supply in an Islamic economy is backed by claims on assets, gold, and foreign currency. A monetarist model of an exchange rate determination from an Islamic viewpoint is then outlined. The model indicates that as long as the money supply increases in the same proportion as the increase in money demand, the exchange rate will be stable. The paper shows that transactions based on Islamic principles have some inherent features of exchange rate stability. Policy implications for stable exchange rate are also pointed out. The establishment of Islamic institutions and financial instruments, however, are preconditions to the development of an international environment that will enable economies to pursue exchange rate policies in accordance to Shariah principles. Key Words: Frequent currency crises in the last two decades has aroused interest in different quarters and a large literature has poured out on the subject.1 Concerned policy makers, central bankers, and researchers have investigated the causes of the crises to draw up appropriate responses to tackle the problem and prevent future occurrences. New theoretical explanations are being sought to understand the currency crisis and suggest remedies for it. Research on the determination of exchange rate and its stability from an Islamic perspective, however, is scant. This paper is a contribution in this area. After deliberating on the nature of money and its demand and supply from an Islamic perspective, the paper outlines a monetarist model of exchange rate determination. The implications of exchange rate stability in an economy that follows Islamic principles are then discussed. The paper is organized as follows. Section 2 outlines the concept of money and briefly surveys the contributions on currency markets and international transactions from Islamic perspective. Section 3 discusses the demand and supply of money in an Islamic economy. Section 4 outlines a monetarist model of exchange rate. The model uses Shariah principles to arrive at the Islamic version. In section 5, the implications of the Islamic principles on exchange rate stability are outlined and the policy recommendations for exchange rate stability are discussed. The last section concludes the paper. 2. Money and Currency Markets: Islamic Perspectives During the Prophet's (PBUH) time, money in circulation were dinar (gold coins) and dirhams (silver coins). Being commodity money, these coins had intrinsic value. A thirteenth century jurist, Ibn Taimiyah, recognizes two functions of commodity money. According to him, money serves as medium of exchange and is used to measure value of goods (unit of account) (Islahi 1988, pp. 140-41). Other than pointing out to money’s function of unit of account, Ibn Khaldun also alludes to the store of value role of money. Money being in the form of gold and silver was considered as ‘treasure and property’ (or wealth) (Ibn Khaldum 1989, p. 298). Classical Islamic thinkers writing on economic issues like Ibn Taimiyah and Ibn al-Qayyim have emphasized the importance of keeping the value of money stable (Islahi 1988 and 1992). Ibn Taimiyah recommends that the volume of fulus (currency) should be in proportion to the volume of transactions so that just prices are ensured. In other words, money supply should be equivalent to its demand to keep the price level stable. Furthermore, he "asks ruler to mint more money of real value without making profit for himself" to prevent any debasement of money (Islahi 1988, p. 139-145). In contemporary terminology, this implies that the central bank should not earn revenue through seigniorage. There are some indications of the concept of exchange rate and its fluctuations in the earlier periods of Islamic rule. Islahi (1988, pp. 42-44) reports that the Mamluk dynasty (1260-1382) inherited a monetary system from their predecessors, the Ayubids, and used three kinds of monetary units - the dinar, dirham and fals (copper coins). The exchange rates between the different currencies were determined by market forces and always fluctuated. During the early periods of reign of Sultan Nasir (1293-1341) one dinar was equal to 25.5 dirhams. After going down to 17 dirhams due to increase in war expenditures, the exchange rate increased to 50 dirhams for a dinar towards the end of his reign (1336). Contemporary fiat money is qualitatively different from commodity money. It does not have any intrinsic value as it is not explicitly backed by any commodity. The status of fiat money or legal tender is decreed by the state. Islamic Fiqh Academy has ruled that fiat money is similar to commodity money, implying that all rules applicable to the latter applies to the former.2 While contemporary Islamic economists accept that money performs all three functions (Ariff 1982, p. 9), some have argued that money should only perform the role of medium of exchange in an Islamic setting (see for example Abu-Saud 1980, p. 77 and Siddiqi 1982, p. 26-27). Abu Saud (1980) and Siddiqi (1982) point out that as money cannot earn interest and is subject to mandatory zakat payments of 2.5 percent annually, it will be costly if hoarded. As such, the store of value function of money will be very limited. Furthermore, they argue that as store of value function of money is not linked to movements in interest rates in an Islamic setting, it will eliminate the volatile speculative demand for money and bring stability in the economy. Abu Saud (1980) and Chapra (1982) also indicate that if the value of money is not stable, then it will not be able to serve the unit of account value function over time. Like the classical writers, contemporary Islamic economists have also emphasized that stability of the value of money should be an important and fundamental goal in the Islamic economic system (Iqbal and Khan 1981, p. 26 and Chapra 1982, p. 148). Among the recent contributions on open economy and exchange rate related writings, Siddiqi (1992) maintains that exchange rate is determined in the market by demand for and supply of currency. Intervention in the currency market by relevant authorities is allowed only to protect and promote public interest (Siddiqi 1992, p.19). Khan (1997) and Kahf and Khan (1992a) discuss how Islamic modes of financing can be used in an international setting. Saadallah (1999) discusses how different modes of Islamic financing can be used in financing trade of various kinds of commodities with different maturities. Tahir (1994) touches on the international capital flows appropriate in an Islamic economy. While discussing different sources of financing development, Iqbal (1991) discusses the pros and cons of different kinds of external financing from an Islamic perspective. Khan (1991) discusses transactions in four different foreign exchange markets (spot, forward, futures, and swaps) from Islamic perspective, concluding the conventional forward, futures and swaps contradict Islamic principles. Tahir (1994) discusses the features of the exchange rate in a fiat money context. He argues that argues that fiat money can be traded in the forward market on principles of bai' muajjal (price-deferred sale) and bai' salam (object-deferred sale) (p. 272). He then discusses how these modes of transactions can be used for international trade to avoid riba (interest).
2.1 Islamic Rules Related to Money and Currency Markets The fundamental principle of exchange between two currencies is based on the following saying of Prophet Muhammad (PBUH): "Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, salt for salt, like for like, equal for equal, hand to hand. If these types differ, then sell them as you wish, if it is hand to hand" (Muslim). The above saying asserts that when commodity money (gold or silver) is exchanged, they should be of equal amount and the transaction should be completed on the spot. As fiat money has been ruled to be similar to commodity money (silver and gold) by the Islamic Fiqh Academy, the rules relating to gold and silver apply to currency. Other rules related to transactions in the money market are given below: Riba Certain transactions involving gharar are prohibited. Gharar refers to the doubtfulness arising from insufficient knowledge of the quantity and quality of a good by one or both parties in the transaction.3 As an extreme case, gharar may take the form of maysir (gambling) which is prohibited in Islam. Pure speculation not based on economic fundamentals may fall in this category. Selling dayn (debt or obligation) for debt or money is prohibited.4 Other than interest on debt transactions, riba has other implications in a foreign exchange market. This means that only spot transactions between two currencies are allowed. As such, transactions in currencies of different denominations in the future are prohibited. Deferred delivery of one currency is prohibited as it amounts to delayed-payment riba (Hamoud 1985, pp. 62-63). The prohibited partial future transactions that may occur in the currency market may be the following: Note that transactions in the form of deferred payment (bai-muajjal) and deferred delivery (bai-salaam) involving goods and real assets are permitted. In international transaction the price of a good can be quoted in a foreign currency. While the exchange rate is determined is the market for foreign currencies by the forces of demand and supply (Siddiqi 1992, p.20), the government/central bank can interfere in the foreign exchange market to protect public interest (the principle of maslahah).5 In the absence of Islamic alternatives, the maxim of necessity making the prohibited lawful will apply.6
In a conventional economy agents involved in foreign currency transactions are traders (exporters and importers), investors, and speculators. Shariah only allows transactions by traders and investors only. The activities of speculators may fall under the category of maysir and, as such, will not exist in an Islamic economy (see point 2 above). Similarly, currency is traded by using spot, forward, futures, options, and swap contracts in conventional currency markets. Of these, transactions in spot markets between two currencies at an agreed upon rate are permitted in Islam. Contemporary forward currency contracts in which both the payment for and delivery of foreign currency are made in the future are not allowed by Islam (see points 6 and 7 above). Futures and options retain this characteristic and add along implicit interest elements in the contracts. As such, these contracts are not compatible with Islamic principles. Swap involve two contracts in a single contract, one being a forward contract, is also not permitted by Islamic rulings. Interest based financing is not approved by Shariah. Thus, all kinds of interest bearing debt (short-term and long-term loans from bilateral, multi-lateral, and private sources) are not permissible. As selling debt is not allowed, selling/buying of conventional interest bearing bonds will not exist in an Islamic economy. As a result, interest payments/receipts will not occur in the current account of an economy based on Shariah principles. Other interest-based transactions (i.e., and borrowing from banks, official creditors, and other sources) under capital account will also be absent in an Islamic economy. Direct investment, capital transfers, and portfolio investment, however, will take place. Note that in the absence of interest-bearing transactions there is a need for Islamic financial instruments for international transactions in an economy. Without Islamic alternatives problems will arise for economies that want to use transactions compatible with Islamic principles in their economies. Foreign capital is required to fill the 'external gap' by most developing countries. Absence of foreign capital, particularly long-term, can affect economic growth adversely. Similarly, short-term capital is needed to meet working capital needs. These genuine needs for capital (short-term and long-term) call for Islamic alternatives that can replace interest-bearing financing. Different Islamic modes of financing have been developed to finance short-term and long-term needs of businesses in a closed economy context (see Ahmad 1993 and Kahf and Khan 1992b). These modes of financing available internally in an Islamic economy can have counterparts in an international setting. The difference between the two, however, will be that in the latter the transactions will go through the currency market. While different modes of financing have been discussed in details for a closed economy in Islamic Economics literature, not much is written for the open economy. The complicating element in financing in an open economy context is that currency risk is added to the overall risk. The burden of the currency risk on different agents will depend on the mode of financing. The long-term and medium-term Islamic financing alternatives can take the form of investment on the basis of profit sharing (mudarabah and musharakah) and leasing capital (ijarah and ijarah wa iqtina). Short-term financing can be funding based on other Islamic modes of financing (like murabahah and bai-muajjal, bai-salaam and istisna). As a result, net borrowing from banks and official creditors will be replaced by net salaam flows (inward salaam minus outward salaam flows) net muajjal flows (inward muajjal minus outward muajjal), etc. in the balance of payments transactions for an Islamic economy. 3. Islamic Money Market: Building Blocks Given the above framework, we now discuss the features of the Islamic version of the money market. We start with the determinants of money demand in an Islamic economy. As mentioned above, classical writers have discussed three functions of commodity money (medium of exchange, unit of account, and store of value). While the medium of exchange and unit of account functions are performed by fiat money, the role of fiat money as store of value, however, will change in an Islamic economy. According to Shariah, money itself cannot earn any returns (interest). Keeping money as store of value will erode the real balances due to inflation and payment of zakat dues. Thus, a Muslim will hold money for transactions purposes only and invest the remaining funds in income-generating assets to reap some return. When the rate of return on these assets increases, there will be a substitution from money towards these assets. The elasticity of demand for money with respect to returns will, however, be very small. Like Khan (1987) and Khan (1995), we postulate that the demand for money in an Islamic economy depends positively on aggregate output Y (arising from transactions purposes) and inversely on the rate of return, r on assets (arising from store of value reasons). The demand for money function can be written as, Md/P = l(r, Y), lr<0 E=P/P*, (7) where E is the exchange rate (defined as the domestic currency price of foreign currency), P is the domestic price level, and P* is the world (foreign) price level. The second arbitrage relates to the financial asset market and called the (uncovered) interest parity (IP). With mobile capital and no transaction costs, short-term capital flows across borders to reap higher rates of return. Mobility of capital gives equality of the rates of return across borders. The interest parity condition is given as, i = i* + e, (8a) where i is the domestic interest rate, i* is foreign interest rate12 and e is the expected rate of depreciation of the domestic currency. Note that the rate of return on foreign assets is the sum of foreign interest rate (i*) and the expected rate of depreciation of the domestic currency (e). The corresponding return parity condition for an Islamic economy is r =r* + e. (8b) Substituting Equations (7) and (8b) in Equation (1) gives the demand for money function in an open Islamic economy as shown below, M/EP* = l(r*+e, Y), lr*+e<0 and lY >0. (9) Money market equilibrium (equating Equations 9 and 6) gives, (Q+ F +G)m/EP* = l(r* + e, Y). (10) Rearranging, we get E = (Q + F + G)m/P* l (r*+e, Y). (11) Equation (11) determines the exchange rate in the monetarist model. If as a result of expansionary monetary policy the growth rate in money supply exceeds the growth in the demand for money, the currency will depreciate. In a conventional economy this may occur if the government sells bonds to the central bank thereby increasing Q in equation (11). Given the money demand, expansion of domestic credit (D Q>0) depreciates the exchange rate. In a fixed exchange rate regime, the central bank has to run down its reserves (DF<0) by an equal amount to keep the exchange rate at the par value. If the reserves exhaust, fixed exchange rate regime becomes insupportable with deficit financing. Flood and Marion (1998) discuss how speculators launch an attack on a currency when expansionary monetary policy that is untenable by reserves is undertaken in an economy. The speculators are active in the currency markets to make a profit on the future movements of the exchange rate. Changes in expected depreciation/appreciation of currency affect the demand for money and as such the exchange rate. Consider an economy with a fixed exchange rate regime where the government is running budget deficits that are financed by the central bank. Deficit financing increases the money supply creating pressure on the exchange rate to depreciate (Equation 11). To keep the exchange rate at par value the central bank has to sell reserves. The speculators expect a depreciation of the domestic currency buy the foreign currency (reserves sold by the central government) in the spot market and short sell the domestic currency in the futures/forward markets. An expectation of depreciation of the domestic currency, therefore, lowers the demand for domestic currency (Equation 9). To keep the money supply in line with the lower demand the central bank needs to sell more reserves. A stage comes when the reserves exhaust. At this point, the par value of the exchange rate cannot be maintained anymore and the currency collapses. The expectations of speculators are realized and they make their profit. 4 Exchange Rate Determination in an Islamic Economy: A Monetarist Approach 5.1 The Financial System The main features of an Islamic financial system are: the absence of interest based financial transactions, debt is created against real activity or assets, debt cannot sold, investments are made on the basis of profit-sharing modes of financing, and transactions involving currency derivatives (like futures and options) are prohibited. We discuss how these characteristics bring about stability in the Islamic financial system. The absence of interest bearing debt will reduce the variability in the exchange rate. This particularly applies to short-term capital that is very mobile. The nature short-term capital in an Islamic economy is different from that in a conventional economy. As pointed out, while short-term capital in an Islamic contract will be sensitive to the rate of return (instead of interest rates), the elasticity will be smaller than that of conventional economies. This stems from not only money demand, but also from the feature of an Islamic debt contract. The basic difference between a debt contract in the conventional economy and Islamic one, is that in the former, debt contract is purely financial, while in the latter it is tied to a real transaction. If the interest rate changes in conventional financial markets, investors can simply sell/buy the bonds immediately. As Islamic financing is tied to real transactions, it cannot be liquidated or sold as soon as the rate of return changes. There is a built in lag in the change in the rate of return and its effect on the capital market. As a result, the disturbance arising from capital mobility due to rate of return changes will be smaller in a currency market of an Islamic economy, making the exchange rate relatively stable. Speculative movement of capital will not exist in an Islamic economy due to two reasons. First, speculative behavior itself is discouraged and second, financial instruments used by speculators are not sanctioned by Islam. This is because short-term capital (so-called hot money) movement by speculators is the main cause of volatility of the exchange rate. A decrease in the movement of short-term capital for speculative reasons will minimize the demand and supply shocks in the currency market. Furthermore, Islamic banks and financial institutions will not finance purely financial transactions related to bonds or derivatives. The absence of speculative movement of capital from the currency markets of Islamic countries will have a sobering effect on the exchange rate. Finally, the principle of profit sharing modes of financing used to reward depositors of the Islamic financial institutions will also have a stabilizing effect not only on the financial system by also on exchange rate. Unlike the conventional counterparts, if there is any negative shock on the asset side of the balance sheet of an Islamic bank, it will be transferred to the liabilities side also. As Islamic financial institutions are not liable to pay a fixed liability on their savings and investment accounts (like conventional banks do in their corresponding deposits), they are in a better position to absorb a negative shock in the economy. In case there is a downturn in an economy and the creditors want to withdraw funds from the country, the conventional banks will have to pay their creditors a fixed amount (irrespective of their asset side positions), but the Islamic banks will pay their depositors according to their asset-side positions. Thus, the total capital flight in case of an economy based on Islamic principles will be less than that of an conventional economy making the exchange rate relatively stable. 5.2 Monetary Policy Note that implicit in Equations (11) is the monetary policy rule that can keep the exchange rate stable. As long as money supply increases in line with the demand for money, exchange rate will be stable. For example, an increase in aggregate output will raise the demand for money. If the money supply increases in the same proportion as the increase in money demand, the exchange rate will not change. As a general rule, when the money supply increases at a lower (higher) rate than the growth rate in money demand, the exchange rate appreciates (depreciates). Given this rule, we now examine monetary and fiscal policies from an Islamic perspective. The basic principle that would govern central bank’s monetary policy in an Islamic economy is that money supply is backed by real assets or claims on real assets (Q) or foreign currency (R). The restriction on central bank's ability to increase the money supply by printing money has important implications on the stability of exchange rate. As money supply can only be increased when real activity increases (DQ>0) or there is surplus in the official settlements balance (DR>0), it cannot deviate much from money demand as in case with deficit financing in the conventional case. Similarly, as pointed out, Islamic banks finance real activity and, as such, money created by these institutions will be directly linked to growth in the economy. As such, there will be little pressure on the exchange rate to depreciate due to excessive money supply. 5.3 Fiscal Policy The rule governing fiscal policy is that the central bank will not be able to finance the government's budget deficit unless the money is used in real productive activity. Governments of Islamic countries should meet their current operational expenditures from their current revenues from different sources. A government can seek financing from the central bank for capital expenditures only. Deficit financing for operational activities of the government should be discouraged.14 When the government seeks funds from the central bank for its capital expenditures and there is an increase in the money supply, there is a corresponding expansion in the productive capacity and output in the economy. Larger output increases the demand for money. As such, expansion of money supply and the demand for money are closely linked. The afore-mentioned fiscal and monetary policies not only discipline the government spending, but also protects a currency from speculative attacks. If the speculators know the central bank finances deficit only for productive capital investments of the government, there will be no incentives to target the currency and destabilize it due to untenable policy-induced reasons. 6. Conclusion The paper discusses a monetarist model to exchange rate determination from an Islamic viewpoint. Exchange rate in this model is determined in the money market. The determinants of the demand for and the supply of money were outlined from an Islamic perspective. The demand for money depends on aggregate output and rate of return on investments. The central bank in an Islamic economy cannot provide the government money in exchange of interest-bearing government bonds. Instead, money supply in an Islamic economy (including that supplied to the government) is backed by claims on assets, gold, and foreign currency. Money supplied by, both the central bank and Islamic banks, is linked to real activity. As long as the money supply increases in the same proportion as the increase in money demand, the exchange rate will be stable. one way to achieve this is that the central bank only finances capital expenditures of the government. The right fiscal policy is to have a balanced budget for current operations, with options of borrowing only for investment purposes. The paper shows that international transactions based on Islamic principles have some inherent features of exchange rate stability. A system operating under Islamic features will diminish the need for quantitative restrictions on capital movements to bring about stability in the exchange rate. The move from conventional modes of international transactions to Islamic ones, however, is difficult as institutions that facilitate these transactions are lacking. The success of moving from conventional international transactions to Islamic ones will depend on the availability of the Islamic compatible financial instruments and the supporting institutions. The establishment of Islamic institutions and financial instruments are preconditions to the development of an international environment that will enable economies to pursue exchange rate policies in accordance to Shariah principles. ---------------------------------------
References Abu Saud, Mahmud (1980), Money, Interest and Qirad, in Khurshid Ahmad (Editor), Studies in Islamic Economics, International Centre for Research in Islamic Economics, King Abdulaziz University, Jeddah and Islamic Foundation, U.K.,59-84. Ahmad, Ausaf (1993), Contemporary Practices of Islamic Financing Techniques, Research Paper No. 20, Islamic Research and Training Institute, IDB, Jeddah. Agenor, Pierre-Richard, Jagdeep S. Bhandari, and Robert P. Flood (1992), Speculative Attacks and Models of Balance of Payments Crises, Staff Papers, International Monetary Fund, 39, 357-94. Al-Dhareer, S. M. Al-Ameen (1997), Al-Gharar in Contracts and its Effect on Contemporary Transactions, Eminent Scholars Lecture Series No. 16, Islamic Research and Training Institute, IDB, Jeddah. Ariff, Mohammad (1982), Introduction, in Mohammad Ariff (Editor) Monetary and Fiscal Economics of Islam, International Centre for Research in Islamic Economics, King Abdulaziz University, Jeddah, 1-23. Blackburn, Keith, and Martin Sola (1993), Speculative Currency Attacks and Balance of Payments Crises, Journal of Economic Surveys, 7, 119-44. Caves, Richard E., Jeffrey A. Frenkel, and Ronald W. Jones (1990), World Trade and Payments, An Introduction, Fifth Edition, HarperCollins Publishers. Chapra, M. U. (1982), Money and Banking in an Islamic Economy, in Mohammad Ariff (Editor) Monetary and Fiscal Economics of Islam, International Centre for Research in Islamic Economics, King Abdulaziz University, Jeddah, 145-76. Choudhry, Nurun N. and Abbas Mirakhor (1997), Indirect Instruments of Monetary Control in an Islamic Financial System, Islamic Economic Studies, 4, 27-66. Flood, Robert P. and Nancy P. Marion (1998), Perspectives on the Recent Currency Crisis Literature, IMF Working Paper, WP/98/130. Frankel, Jeffrey A., and Andrew K. Rose (1995), Empirical Research on Nominal Exchange Rates, in Gene Grossman and Kenneth Rogoff (Eds.), Handbook of International Economics, North-Holland, Amsderdam, 1689-1729. Hamoud, Sami Hassan (1985), Islamic Banking, Arabian Information, London. Ibn Khaldun (1989), The Muqaddimah: An Introduction to History, (translated by Franz Rosenthal), Princeton University Press, Princeton, N.J. Iqbal, Munawar and M. Fahim Khan (1981), A Survey of Issues and A Programme for Research in Monetary and Fiscal Economies of Islam, International Center for Research in Islamic Economics, King Abdul Aziz University, Jeddah and Institute of Policy Studies, Islamabad. Iqbal, Munawar (1991), Financing Economic Development, in A.M. Sadeq, A.H. Pramanik, and N.M.H.N. Hassan (Editors), Development and Finance in Islam, International Islamic University Press, Malaysia. IRTI and IFA (2000), Resolutions and Recommendations of the Council of he Islamic Fiqh Academy, 1985-2000, Islamic Research and Training Institute, Islamic Development Bank, Jeddah. Islahi, Abdul Azim (1988), Economic Concepts of Ibn Taimiyah, Islamic Economics Series 12, The Islamic Foundation, Leicester, U.K. Islahi, Abdul Azim (1992), Economic Concepts of Ibn Taimiyah, in AbulHassan M. Sadeq and Aidit Ghazali (Editors), Readings in Islamic Economic Thought, Longman Malaysia, Petaling Jaya. Johnson, H. (1972), The Monetary Approach to the Balance of Payments, in Further Essays in Monetary Theory, Allen and Unwin, London. Kahf, Monzer (1997a), The Use of Assets Ijara Bonds for Bridging the Budget Gap, Islamic Economic Studies, 4, 75-94. Kahf, Monzer (1997b), Comments on Islamic Financial Instruments: The Case of Malaysia, in Ausaf Ahmad and Tariqullah Khan (Editors), Islamic Financial Instruments for Public Sector Resource Mobilization, Seminar Proceedings No. 39, Islamic Research and Training Institute, IDB, Jeddah. Kahf, Monzer and Tariqullah Khan (1992a), Alternative Strategies of International Financing, in M.A. Mannan, M. Kahf, and A. Ahmad (editors), International Economic Relations from Islamic Perspectives, Islamic Research and Training Institute, IDB, Jeddah. Kahf, Monzer and Tariqullah Khan (1992b), Principles of Islamic Financing, Research Paper No. 16, Islamic Research and Training Institute, IDB, Jeddah. Khan, Mohsin (1987), Islamic Interest-Free Banking: A Theoretical Analysis, in Mohsin Khan and Abbas Mirakhor (Editors), Theoretical Studies in Islamic Banking and Finance, The Institute for Research and Islamic Studies, Houston. Khan, Muhammad Akram (1991), "Commodity Exchange and Stock Exchange in an Islamic Economy", in A.M. Sadeq, A.H. Pramanik, and N.M.H.N. Hassan (Editors), Development and Finance in Islam, International Islamic University Press, Malaysia. Khan, M. Fahim (1995), A Simple Model of Income Determination, Growth and Economic Development in the Perspective of an Interest-Free Economy, in M. Fahim Khan, Essays in Islamic Economics, The Islamic Foundation, Leicester. Khan, Tariqullah (1997), Interest-free Alternatives for External Resource Mobilization, Research Paper No. 44, Islamic Research and Training Institute, IDB, Jeddah. Khan, Tariqullah and Habib Ahmed (2001), Risk Management: An Analysis of Issues in Islamic Financial Industry, Occasional Paper No. 5, Islamic Research and Training Institute, IDB, Jeddah. Khayrullah, Walid (1994), Al-Muqaradah Bonds as the Basis of Profit-Sharing, Islamic Economic Studies, 2, 79-102. Krugman, Paul (1979), A Model of Balance of Payments Crises, Journal of Money, Credit and Banking, 11, 311-25. Obstfeld, Maurice (1986), Rational and Self-Fulfilling Balance of Payments Crises, American Economic Review, 76, 72-81. Obstfeld, Maurice (1994), The Logic of Currency Crises, NBER Working Paper No. 4640, National Bureau of Economic Research, Massachusetts. Obstfeld, Maurice (1996), Models of Currency Crises with Self-fulfilling Features, European Economic Review, 40, 1037-47. Saadallah, Ridha (1999), Financing Trade in an Islamic Economy, Research Paper No. 51, Islamic Research and Training Institute, Islamic Development Bank, Jeddah. Salvatore, Dominick (1993), International Economics, Forth Edition, Macmillan Publishing Company, New York. Sargent, Thomas J., and Niel Wallace (1982), The Real Bills Doctrine versus the Quantity Theory: A Reconsideration, Journal of Political Economy, Vol. 90, pp. 1212-36. Siddiqi, Muhammed Nejatullah (1982), Islamic Approach to Money, Banking, and Monetary Policy - A Review, in Mohammad Ariff (Editor) Monetary and Fiscal Economics of Islam, International Centre for Research in Islamic Economics, King Abdulaziz University, Jeddah, 25-38. Siddiqi, Muhammed Nejatullah (1992), Principles of International Economic Relations in Islam, in IRTI Proceedings, Islamic Perspectives on International Economic Relations, IRTI, Jeddah. Sproul, Micheal F. (1997), The Real Bills Doctrine: A Restatement, Working Paper ewp-mac/9711001, http://econwpa.wustl.edu. Tahir, Sayyid (1994), Prospects for International Transactions Without Riba, in Elimination of Riba from the Economy, Institute of Policy Studies, Islamabad, Pakistan. Zarqa, M. Anas (1997), Istisna' Financing of Infrastructure Projects, Islamic Economic Studies, 4, 67-74.
To determine the exchange rate, we use a monetarist model that represents the first generation currency crisis models.10 The advantages of the monetarist model are that it is simple and can be used to discuss the effects of monetary and fiscal policy (deficit financing) on the exchange rate. The monetarist model presented below is a modified and extended version of that used by Flood and Marion (1998) and Frankel and Rose (1995). The economy under consideration is small and open. We use two parity conditions to link the economy to the rest of the world. Two theories of exchange rate determination derived from arbitrage conditions are widely used in open-economy macroeconomics. The first relates to arbitrage in the goods market is the purchasing power parity (PPP). PPP has evolved to be one of the prominent theories of exchange rate determination with fiat money. Under PPP, the exchange rate is determined by arbitrage as the ratio of the price levels (or inflation rates). 11 Exchange Rate, Monetarist model, Islamic economy.
1. Introduction |
