Download Macroeconomics within Islamic Framework (Advanced Level)

Macroeconomics within Islamic
Framework (Advanced Level)
Dr. Sayyid Tahir
IIIE, IIU
IRIT, DL– 10 (17 Nov 2009)
The Target
• In DL-8 we focused more on conceptual matters such
as Islamic economy, nature and role of government
and economic policy.
• We also took note, albeit briefly, of the Islamic
economics literature produced mostly in the 1980s
and the 1990s parallel to that in the traditional
macroeconomics.
• In DL-10 we take a comparative look at Islamic
macroeconomics from an Islamic perspective and
review some of the past analytical developments in
the area.
IRTI, DL - 10 (17 Nov 2009)
2
Traditional Macroeconomics
1.
The target variables are Y, P, r (interest rate), N
(employment), w (wage rate) and π (inflation)
----
2.
3.
4.
5.
Distribution issues are recognized but clubbed
under lump sum transfer payments
The subject is concerned with description and
prescription
On the description side the economy is taken as
it is.
Nature & role of government + macroeconomic
policy (both targets and instruments)
The method of analysis: ‘As is’ approach
IRTI, DL - 10 (17 Nov 2009)
3
Macroeconomics in an Islamic
Perspective (Islamic Macroeconomics)
1. The target variables are likely to be Y, P, markup in
deferred-payment contracts and profit-sharing ratio,
N (employment), w (wage rate) and π (inflation) as
well as poverty and inequality
2. The subject is concerned with description as well as
prescription.
3. On the description side the economy is taken as
either an “ideal Islamic economy” or “the existing
macroeconomic setup as departure from the
comparable an Islamic set up”
4. Nature & role of government + macroeconomic policy
(both targets and instruments)
5. The method of analysis: ‘As is’ approach
IRTI, DL - 10 (17 Nov 2009)
4
Comparison
Traditional
The Islamic
1. Target variables
2. Description (on as is basis)
and prescription (on the
basis of good and bad)
3. Nature and role of
government and economic
policy
1. Target variables
2. Description and
prescription in the light of
the Shari’ah principles
3. Nature and role of
government and economic
policy [with the maximum
leeway for private initiative
on both the economic and
the distribution sides)
4. Method of analysis
4. Method of analysis
IRTI, DL - 10 (17 Nov 2009)
5
Ausaf Ahmad (1987 – 1983/4)
1. A Model of Income Determination in an
Islamic Economy (Jeddah: IERC, KAU, 1987)
2. A pioneering work that sought to lay down
foundation of Islamic macroeconomics
3. The author consciously seeks to present
Islamic income determination model against
the backdrop of the simple Keynesian model.
IRTI, DL - 10 (17 Nov 2009)
6
Ausaf Ahmad (1987) – contd.
1st Model:
Y=C+I
I = I0
C = C 1 + C2
C1 = a + b[Y – Z – E] 0<b<1
C2 = Z + E
Z = z.Y
0<z<1
E = γ.Y
0< γ <1
2nd Model:
Y=C+I+G
I = I0
G = G0
C = C 1 + C2
C1 = a + b[Yd – Z – E] 0<b<1
C2 = Z + E
Yd = Y – T
T = t.Y
Z = z.Y 0<z<1
E = γ.Y 0< γ <1
C1 and C2 — consumption expenditures of the rich and the poor
Z and E — zakah and infaq going from the rich to the poor
Other symbols have their usual meaning.
IRTI, DL - 10 (17 Nov 2009)
7
Ausaf Ahmad (1987) – contd.
3rd Model:
I = I(Y, μ)
S = I(Y, μ)
S=I
Z = z.Y
(∂I/∂Y)>0,
(∂S/∂Y)>0,
(∂I/∂μ)<0
(∂S/∂μ)>0
E = γ.Y
μ is savers’ profit-sharing ratio
Analysis:
1. The author holds the view that Islamic economy is like
the conventional economy except that there is the
system of zakah and that interest is absent.
2. The 1st and the 2nd models: novelty in the consumption
function. Results are expected.
3. 3rd Model: Incomplete
IRTI, DL - 10 (17 Nov 2009)
8
Mohsin S. Khan (1986 - 1985)
1. Mohsin S. Khan, “Islamic Interest-Free Banking”,
IMF Staff Papers, 33(1), 1986, 1-27
2. The focus is on monetary matters.
3. The author seeks to establish three things:
(a) If Muslim countries move to Profit-&-loss-Sharing(PLS-) based that should not be a cause for concern
for policy makers at the international level.
(b)PLS-based banking is not an entirely new idea
(c) A PLS-based financial system is likely to be more
stable than the interest-based system.
(d)There would be no difference in the working of
monetary policy as at present.
IRTI, DL - 10 (17 Nov 2009)
9
Mohsin S. Khan (1986) – contd.
Assumptions:
• The economy consists of three markets: a market for
goods, a money market and a capital market.
• All real income goes to capital rather than being divided
between capital and labor.
• Banks are the only intermediaries. The savers deposit all
their savings with the banks, and all investments in the
economy are undertaken by borrowing from banks.
• When the savers deposit their saving with the banks, they
essentially buy “shares” of banks whose nominal value is
not guaranteed and the rate of return on them is not
predetermined and can vary.
IRTI, DL - 10 (17 Nov 2009)
10
Mohsin S. Khan (1986) – contd.
Symbols:
y = real income (GDP)
r = real yield or real rate of return on shares
S = nominal value of shares
P = price level
s = real value of shares
IRTI, DL - 10 (17 Nov 2009)
11
Mohsin S. Khan (1986) – contd.
Capital Market:
Demand for Bank shares: s = S/P
Supply of Bank shares: y/r
Equilibrium condition: s = S/P = y/r
• Balance Sheet of the Banking System &
Adjustment in the Capital Market:
Assets
Liabilities
y/r
S/P
When losses occur, nominal value of shares (S) is wiped off and
the capital market instantaneously returns to equilibrium.
IRTI, DL - 10 (17 Nov 2009)
12
Mohsin S. Khan (1986) – contd.
Money Market:
• Economic agents hold their total real wealth (W) in the
form of either real money balances (m = M/P) or shares
of the banks (s = S/P).---P = 1 (constant). That is: w = m+s
• All money in the system (M) is outside money or currency
supplied by the government.
• Working Hypothesis: People always maintain a constant
ratio of real balances (m) to shares (s = S/P) that, in turn,
is an inverse function of real rate of return (r):
m/s = g(r), g′ < 0
Money Market Equilibrium condition: m = g(r).s = g(r).[y/r]
IRTI, DL - 10 (17 Nov 2009)
13
Mohsin S. Khan (1986) – contd.
• Aggregate demand (yd) equals consumption demand
(C) plus investment demand (I).
C = C(W, r), CW < 0, Cr > 0; W = m + s = m + (y/r)
I = I(r),
Ir < 0
yd = C(W, r) + I(r)
• if producers are offered in real terms y, they would
supply output worth y. Thus, ys = y
Goods Market Equilibrium Condition: y = C(Y, r) + I(r)
• Adjustment Mechanism:
As usual.
IRTI, DL - 10 (17 Nov 2009)
14
Mohsin S. Khan (1986) – contd.
Real rate of
return (r)
LM
r*
B
A
r1
IS
C
y1
y*
y
Real income ( )
The capital market remains in equilibrium by default.
IRTI, DL - 10 (17 Nov 2009)
15
Iqbal Mahdi and Mahyoub al-Asaly
(1991 – 1987)
1. Iqbal Mahdi and Saif Al-Asaly, “A Model of Income
Determination in an Interest-Free Islamic Economy”
in F.R. Faridi (ed.) Essays in Islamic Economic Analysis
(New Delhi: Genuine Publications, 1991), pp. 52-66.
2. Requirements of Isl. Economy are two: no interest
and imposition of zakah.
3. IS-LM framework adopted.
4. Banks replace interest rate by PLS-ratio P that stands
for “percentage of expected profit given to the bank
as an equity owner in business” (p.57).---the
percentage of profit going to the capital
IRTI, DL - 10 (17 Nov 2009)
16
Iqbal Mahdi & Al-Asaly (1991) – contd.
Equilibrium in the Goods Market – The IS Curve:
Y = C + I + G t + GZ
C = f(Yd)
f′>0
Yd = Y – T – Z
Z = z.S - - - - - - [Zakah is on savings.]
I = I(P)
I′ < 0) - - - - - P is a PLS ratio
Gt and GZ are tax- and zakah-based government
expenditures, respectively (Exogenously given)
Equilibrium in the Money Market – The LM Curve:
Ms = Md
Ms = M0
Md = m(Y,P),
IRTI, DL - 10 (17 Nov 2009)
(δm/δY)>0, (δm/δP)<0
17
Iqbal Mahdi & Al-Asaly (1991) – contd.
P
LM
A
P*
IS2
P
LM
IS
A
P*
Y
Y*
Diagrammatic Analysis – Expansionary Fiscal Policy
IS
P
LM
Y*
Y
LM1
A
P*
Diagrammatic Analysis
IS
Y*
Y
Diagrammatic Analysis – Expansionary Monetary Policy
IRTI, DL - 10 (17 Nov 2009)
18
Zaidi Sattar (1991 – 1987)
1. Zaidi Sattar, “Interest-Free Banking, ProfitSharing and the Islamic Macroeconomic
System” in F.R. Faridi (ed.) Essays in Islamic
Economic Analysis (New Delhi: Genuine
Publications, 1991), pp. 82-101.
2. Assumptions: Closed economy with zakah,
banks intermediating between savers and
investors and a constant price level (=1).
IRTI, DL - 10 (17 Nov 2009)
19
Zaidi Sattar (1991) – contd.
Goods Market:
Y=C+I+G
C = C(Yd, W)
I = I(p)
Yd = Y – T
CY>0, CW>0
I′>0
and
T = tY,
0<t<1
Money Market (Price Level equals 1):
Ms = Md
M0 = M(Y, p)
MY>0, Mp<0
p is “the expected (realized) rate of profit. G and W are
exogenously given.----The analysis is based on linear
versions of the various relations.
IRTI, DL - 10 (17 Nov 2009)
20
Zaidi Sattar (1991) – contd.
LM
p
(rate of
return)
IS
Red Arrows: Direction
of movement in “p”
w. r. to excess DD/SS in
the Money Market
Y (Real Income/output))
Green Arrows: Direction of movement in “Y” w. r. to
excess DD/SS in the Goods Market
Stability under Various Policy Scenarios: Results depend on slopes of IS and LM curves
IRTI, DL - 10 (17 Nov 2009)
21
Fahim Khan (1996 - 1992)
1. M. Fahim Khan, “A Simple Model of Income
Determination and Economic Development in the
Perspective of Interest-Free Economy”, in M.A.
Mannan (ed.), Financing Development in Islam
(Jeddah: IRTI, IDB, 1996), pp. 79-108.
2. Assumptions: A closed economy where the price
level remains fixed. Zakah issues also do not apply.
3. Investment is an inverse function profit-sharing ratio
(a) while expected profitability of the enterprises in
the economy (R) is exogenously given and remains
constant.
IRTI, DL - 10 (17 Nov 2009)
22
Fahim Khan (1996) – contd.
The Model
Goods Market:
Y=C+I+G
C = b0 + b(1 – t)Y
I = i0 – ia
Money Market: [M/P]S = [M/P]D - - - - - P=1
[M/P]S = [M/P]
[M/P]D = LA = kY – h′a
a = profit-sharing ratio for the owner of investment funds
h′ = a function of expected profits on financial assets; the said
expected profits are exogenously given
b0, b, t, i0, i and k are other positive constants with the usual
restrictions on their size.
IRTI, DL - 10 (17 Nov 2009)
23
Fahim Khan (1996) – contd.
Analysis and Results:
1. The LM curve becomes LAM curve, and the model
an IS-LAM model.
2. The LAM curve is presumed to have a horizontal
segment at low levels of real income, an upward
sloping part in the middle range and a vertical part
at high levels of real income.----The three stages are
taken to be synonymous with level of development.
3. Conclusions about the effectiveness of the various
are similar to those drawn in traditional
macroeconomics in the income-interest rate plane.
IRTI, DL - 10 (17 Nov 2009)
24
Muhammad Anwar (1987)
1. Muhammad Anwar, Modeling Interest-Free
Economy (Va.: International Institute of Islamic
Thought, 1987), pp. 27-60.
2. Anwar presents a full-scale macroeconomic
model that is a modified version of Sargent’s
1979 model.
3. Assumptions:
(a)
(b)
of
IRTI, DL - 10 (17 Nov 2009)
A closed economy
The focus is purely on the monetary side
the economy. ---- No zakah considerations.25
Muhammad Anwar (1987) – contd.
Sargent’s 1979 Classical Model
Dr. Anwar’s 1987 Model
w/p = FN(K, N) (Demand for labor)
N = N(w/p)
(Supply of labor)
Y = F(K, N)
(Agg. Prod. Func.)
C = C [Y - T - δK - {(M+B)/p}π +
{q ( K, N, r - π, δ) - 1}.I; (r π)] (Consumption Function)
I = I(q-1) = I[q(K, N, r-π, δ) - 1]
w/p = FL(K, L)
L = L(w/p)
Y = F(K, L)
C = C [Y - T - δK - {(M+Φ)/p}π +
{η(K, L, k, θ, δ, π) - 1}.I; (kθ π)]
I = I{η(K, L, k, θ, δ, π) - 1}
(Investment Function)
Y = C + I + δK + G
[M/P] = m (r, Y)
IRTI, DL - 10 (17 Nov 2009)
(IS Curve)
(LM curve)
Y = C + I + δK + G
[M/p] = m(k, Y)
(IS Curve)
(LM curve)
26
Muhammad Anwar (1987) – contd.
Interest-based Economy
r = rate of interest
δ = rate of capital depreciation
π = anticipated rate of inflation
r + δ – π = the user cost of capital
q = FK – [(r + δ – π)/(r – π)] + 1 = FK – {δ/(r – π)} = q(K, N, r – π, δ)
B = nominal value of outstanding bonds
Interest-free Economy
θ = normal profit rate in the economy
k = profit-sharing ratio of the financier
k θ + δ – π = the user cost of capital
η(K, L, k, θ, δ, π) substitutes q in interest-based economy.
Φ = nominal value of outstanding mudarabas
IRTI, DL - 10 (17 Nov 2009)
27
Muhammad Anwar (1987) – contd.
Results:
Similar to those of Sargent for his model of
interest-based economy.
1.Fiscal effects on profit-sharing ratio (k),
investment (I), consumption (C) studied.
2.On the monetary side, neutrality of money
and dichotomy between the real and the
monetary sectors endorsed!- - - -(pp.55-6)
IRTI, DL - 10 (17 Nov 2009)
28
Mohammad Hussain (1994)
1. Muhammad Hussain, “A Comprehensive
Macroeconomic Income Determination for an Islamic
Economy”, The Pakistan Development Review, 33: 4
Part II (Winter 1994), pp. 1301-14.
2. A full-scale model is presented with the demand as
well as the supply sides.
3. Assumptions: A closed economy with government,
zakah factors and “the real rate of profit that an
investor has to share with a financier-Rabb-ul-mal . . .” - -The said rate of profit is both a factor price for
obtaining money capital and opportunity cost of
holding idle funds by the financier.
IRTI, DL - 10 (17 Nov 2009)
29
Muhammad Hussain (1994) – contd.
Demand Side of the Economy - The Goods Market:
y=c+I+g
c = c1 + c2
c1 = c[y – t(y) – z – e]
c2 = z + e
t = t(y)
z = z(y)
e = e(y)
i = i(r)
g = g0
c′, t′, z′ and e′ are supposed to lie between 0 and 1,
and 0<(c′+t′+z′+e′)<1
Slope of IS Curve:–
[dr/dy]IS = [1 – c′ (1–t′ ) – (1 – c′ )(z′ + e′ )]/i′ < 0
IRTI, DL - 10 (17 Nov 2009)
30
Muhammad Hussain (1994) – contd.
Demand Side of the Economy - The Money Market:
[M0/P] = m = l(r) + k(y)
Slope of LM Curve:
IRTI, DL - 10 (17 Nov 2009)
i′ < 0, k′ > 0
[dr/dy]LM = – (k′/l′) > 0
31
Muhammad Hussain (1994) – contd.
Supply Side of the Economy:
Aggregate Production Function:y = NαK1–α
Equilibrium in Labor Market:
𝜕y/𝜕N = αy/N = w(N)
w′ > 0
Equilibrium in Capital Market:
𝜕y/𝜕K = (1 – α)y/K = r
The three equations together yield equation of the YQ
curve as follows:
y[α – {(1 – α)/r}(α – 1)/α.w(N)] = 0
Slope of YQ Curve (see also the diagram):
[dr/dy]YQ = – αr/(1 – α)y][(N2.w′ )/(αy + N2. w′ )]
IRTI, DL - 10 (17 Nov 2009)
32
Muhammad Hussain (1994) – contd.
LM
r
LM′
YQ
IS
Y
IRTI, DL - 10 (17 Nov 2009)
33
Some Other Notable Mentions
1. Mohsin S. Khan and Abbas Mirakhor, “The Financial
System and Monetary Policy in an Islamic Economy”
M.S. Khan and A. Mirakhor (eds.), Theoretical Issues
in Islamic Banking and Finance, Houston, Texas: The
Institute for Research and Islamic Studies, 1987.
2. M.M. Metwally, Macroeconomic Models of Islamic
Doctrines, London: J.K. Publishers, 1981. (see also
JKAU, 1(1), 1983, pp.3–33, Arabic Section)
3. There are also some works on consumption
function and investment functions in an Islamic
economy.
IRTI, DL - 10 (17 Nov 2009)
34
The Way Forward
1. Reconstruct macroeconomics from the Islamic
perspective.
2. Basic Shift: We need to highlight the Islamic
emphasis on distributive matters and bring in
innovations on the financial side
3. An Example: S. Tahir, “Towards a Theory of
Aggregate Output, Income and Economic
Inequalities Determination in an Islamic
Economy”, Journal of Islamic Economics, 2(2), July
1989, pp. 95-108. (Originally 1985)
IRTI, DL - 10 (17 Nov 2009)
35
S. Tahir (1989) – contd.
Assumptions:
Closed economy, constant price level (= 1), no financial
considerations and exogenously determined
distribution of income associated with the production
process among Poor (the have-nots) and Rich (the
haves)
Equilibrium Condition:
Y = C 1 + C2 + I + G
Degree of Inequality/Disparity D = [α1 – η1]/(α1α2)½
where η1 = [Yd1/(Yd1+Yd2)] and α1 and α2 are proportions
of the poor (have-nots) and the rich (haves) in total
population; α1+α2 = 1
IRTI, DL - 10 (17 Nov 2009)
36
S. Tahir (1989) – contd.
Accounting Relations:
Yd1 = θ1Y + λY + δW + R
θ1+θ2 = 1
Yd2 = θ2Y – λY – δW – T
------------- θ1 and θ2 are exogenously given.
Behavioral Relations:
C1 = A + aYd1
A>0, 0<a<1
C2 = B + bYd2
B>0 0<b<a<1
T = T0
R = R0
W = W0
I = I0
G = G0
IRTI, DL - 10 (17 Nov 2009)
37
S. Tahir (1989) – contd.
Notable Features of the Model:
1. Disaggregation introduced in the aggregate consumption
function. MPC of the Poor > MPC of the Rich.
2. The poor (the have-nots) are those who receive zakah paid
by the rich (the haves). Zakah is paid on the output flows
(such as agricultural and mineral output—a component of Y)
as well as wealth carried over from the past (W). Proportions
of the poor and the rich in total population, respectively, are
α1 and α2. Moreover, α1+α2 = 1.
3. The rich also pay taxes, and the poor also receive transfer
payments. Both of these are exogenously determined.
4. Taxes and transfer payments are kept in the model in order
to underscore the point that there may be taxes and transfer
payment in an Islamic economy. The latter would arise
IRTI, DL - 10 (17 Nov 2009)
38
S. Tahir (1989) – contd.
The Solution:
Ye = ψ1E + ψ2Y
where
E = A+B+I0+G0+aR0-BT0
ψ1 = 1/[1-(θ1a+θ2b)-λ(a-b)] (expenditure multiplier)
ψ2 = δ(a-b)/[ 1-(θ1a+θ2b)-λ(a-b)] (wealth multiplier)
De = [α1 – η1e]/(α1α2)½
IRTI, DL - 10 (17 Nov 2009)
39
S. Tahir (1989) – contd.
Policy Analysis:
Besides the traditional fiscal policy analysis, one
may also explore Islamization of economy as an
economic policy.
1. Read the model while suppressing the zakah
parameters λ and δ, and re-calculate the
equilibrium values of Y and D, say Yp and Dp.
2. Compare Yp and Dp with Ye and De derived
earlier and draw the necessary conclusions.
IRTI, DL - 10 (17 Nov 2009)
40
Thank you.
IRTI, DL - 10 (17 Nov 2009)
41