A Dynamic Stochastic General Equilibrium (DSGE) analysis of an economic system that partially or fully complies with Islamic principles

Overview

The prohibition of interest in Islamic economics presents an alternative economic paradigm to secular interest-based systems. If adopted, interest-free financing predicated on equity participation rather than debt obligations would radically transform an economic system, potentially leading to greater resilience to shocks and economic crises, and a more socially just distribution of wealth.

However, the body of academic literature in Islamic economics developed over the last four decades since the renaissance of Islamic economic thought is almost entirely lacking in the type of quantitative rigour that would unlock far deeper insights into how the separate parts of the system, so far studied in partial equilibrium, come together and interact. Claims made that economic outcomes dominate those of secular economies have rational conceptual underpinnings, but have not been developed using modern quantitative techniques, particularly DSGE.

This project aims to apply DSGE modelling techniques to a stylized Islamic economy in order to understand and quantify the economic outcomes that result from a prohibition of interest, the profit and loss sharing basis of financing arrangements, and the payment of a mandatory tax on hoarded wealth used to finance welfare for the poor. The DSGE model developed in the project would also be calibrated using actual economic data.

Research questions addressed by this project:

• Is an Islamic economic system more resilient than a secular system to shocks? If so, to what extent? Does this resilience depend on the type of shocks?
• Does an Islamic economic system result in a more socially just/equitable distribution of wealth? If so, to what extent?
• How does the wealth tax change the behaviour of households, firms and the government?
• How does a tax on hoarded wealth interact with government taxes on income and influence fiscal policies?
• How should monetary policy be formulated in an Islamic economic system given that interest rates cannot be used to manage inflation, and traditional open market operations cannot be used to manage the money supply?
• Can an Islamic economic system reduce the natural rate of unemployment?
• Do the principles of an Islamic economic system lead to higher growth and greater efficiency?
• How should monetary and fiscal policies be developed for dual economic systems that have both secular and Islamic economic agents and structures?

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