Existence and Stability of Equilibrium in an Islamic Economics - Essay Example

Existence and Stability of Equilibrium in an Islamic Economy al Affiliation) One of the crucial objectives of Islamic economy is to replace the interest rate type of banking with banking of profit and loss sharing. The Islamic banking concept had been already popular in 1970. However, it was necessary to carry out more research on the implications of the new system on investment, stability, and investment in the economy, and subsequent effects of monetary policy. The paper critically evaluates and finds the stability and equilibrium Islamic economy using some of the theoretical models to address various apprehensions. Conversely, there are various questions related to new criteria because it is supposedly thought that the new system has no meaningful change in the monetary tools and policy. Therefore, the Islam has proposed the risk and profit sharing mechanism. Using an equilibrium model, the paper further investigates the implications of adopting the banking for stabilization and equilibrium. It has analyzed the long term implications of Islamic banking on the capital flows and the capacity of the economy to readjust the disturbance. It has concluded that monetary policy can be used to stabilize the economy and asset position disturbance will be absorbed well in Islamic economy. The paper further concludes that borrowing the external resources through profit and risk sharing models are streamlined to productive investments. The investments can generate cash inflows to repay loans from foreign countries. Additionally, the Islamic economy has the ability to adjust the disturbances of macro economy that need the resource shifting to non-traded sectors to trade sectors. Introduction Recently, interest has gained discussions when analyzing the economy of Islam. The paper integrates and expands the outcomes of certain mechanism that were adopted in studying the policies of stabilization in Islamic economy. The likelihood that monetary policy can stabilize the economy was dismissed against charging interest rates, which were demonstrated by Mirakhor and Khan. Embracing the short-run macroeconomic model of a closed economy, it shows that the Islamic economy has no crucial change on the economic variables when monetary policy is employed. The authority can attain similar outcomes by controlling the supply of bank lending as this can similarly be achieved by varying the supply of money. Consequently, the paper further analyses the scenario in open-economy (Grinols & Turnovsky, 1991). This endeavor, apart from its interest, it clarifies the relationship between the real sector and the financial industry in Islamic economy. Specifically, the evaluation is done on the canals where the monetary policy changes the rate of return on the real and financial assets, hence affecting the output, balance of payment, and output. The paper discusses the equilibrium model for the Islamic economy. The model illustrates how the changes in the holding of the government will affect the rate of return and how the substitution of the assets affects the monetary policy outcome. It further presents the relationship between savings and investments an Islamic economy and the account deficit. The last section of the paper discusses the concluding remarks. Stability and Equilibrium in Islamic economy Model Using the Arrow Debreu type of model it can be outlined to what degree the stability and equilibrium conditions will be affected when the interest do not exist in the Islamic economy as capital price. This means specifying a pricing technique to convert a product in a single period to similar commodity in another time. It is assumed that uncertainty is absent, real products can be exchanged through monetary means as medium of exchange and no commodity can be exchanged for similar products. When there is no interest, the existence of stability, and equilibrium of Arrow-Debreu model. It is also argued that the assumption of uncertainty can be removed without implicating the model. Risk is taken as a product that has price termed as the profit. An important assumption is that time has no price. Therefore, time pricing only occurs when a product in a single time undergoes exchange for same product in another time. However, it can be emphasized that Arrow-Debreu model cannot describe the Islamic economy, since market in the Islamic benchmark is not the only exchange institution. Non-market institutions are substantial in Islamic economy and thus cannot be dismissed. The market institutions cannot attain all the goals of the Islamic system but only achieves efficiency. This should be brought into focus that studying general equilibrium in the economy needs a different benchmark that is yet to be developed. Therefore the model can be summarized using the following assumptions The Islamic economy The equation satisfies the above assumptions. The Arrow-Debreu for the Islamic economy equilibrium will be  The expression will satisfy: J=1,…….., J, y, Arg max  For all  And when  For every  Analyzing the consequences of the economy to trade in assets and goods can easily be simplified and modified. Money is added as an asset having a zero nominal return. The retained earnings can be dismissed through assumptions that shares in an economy is equal to using the earnings to purchase shares in the company. The share number is equal to capital goods; E=K, the aggregate supply is taken to be a capital function The rate of return is taken to be r=dFP/Pe P is taken to be the price level, while Pe is the shares nominal price, dFP is the marginal product of K. when the prices of shares are defined,  The rate of return will be  The capital gain and profits will be  Hence  Real wealth is defined as  where m is the real balances stock. The demand equations for the assets (good, equity, and money) will have The equilibrium in goods, money, and equity shares markets are given by Q is taken to be the aggregate supply, PL is money demand in nominal terms.  From the above equation, stability can be determined when y=AD, E=K and I is 0. The conditions can only be met when m=m*, k=k*, and r=r*. Assuming the price is P, then the exchange rate will be  While focusing on the good’s trade, the short-equilibrium will be attained as below where T= Trade Balance. The following differential equation determines the adjustment process’ dynamic structure .. Allowing trading of assets and goods, the short-run equilibrium will become When the return payment on the foreign holding of the domestic equities is done, y=F(K)-F*iEf, will modify the above equations to form 43.  Thus resulting to the simultaneous systems below 44.  T and Ef can be determined when M and K are affected, thereby yielding 45..  46.  47. .  48. Determinant D is 49. 50. The above equation shows the deficit or surplus Bop and is the approach to Bop. Through the process of linearization the below coefficient matrix would be 51.  The determinant will be Assuming we have an initial position and the adjustment path is not oscillating, the adjustment process properties can be discussed. The long-run stability will be found when K and M are 0. Therefore, using Wairas rule, we will have When M and K are substituted with given rf and pf and the short-run equilibrium state, the long-run equilibrium will undergo trading in assets and goods as Assuming there is no trade, the long run equilibrium will be 54.  From the equations, it is clear that the positions of the long-run equilibrium of the economy after and before trade are totally different. When a nation starts trading in equity claims and goods, the foreign investors will reserve the local equity shares assuming the ROR on local equity is higher than the foreign RoR on the same assets. The above model can be used in showing interest-free system properties within the macroeconomics model. The model can therefore, be extended to show the methods and concepts of the economy employed in analyzing Islamic economic issues. It is assumed that trading of the nth asset will be at period 0, before the assets experience any risks, . Additionally, the assets need to be indexed with history of events. Therefore,  is the price of nth asset consumption at time 0, delivered at time t when the history’s event of  is realized. Here, the equilibrium is the same assuming we have 2 assets, assuming risks are limited. The arrow equilibrium for the nth asses will be priced at { Their allocation will be { Such that assuming {For asset=1, 2,………nth asset, {this will solve { Subject to It is kind straight forward to define the equilibrium prices for the nth asset. When the FOC are taken in respect to  yields When the assets are combined Implying The above implies The aggregate endowment will be The resource constraint for the assets will be With the pricing of Arrow Debreu, additional assets can also be priced Consider the nth asset as j, with dividend  the cum dividend for the assets will be  The ex-dividend of the nth asset will be The pricing of the asset work their returns, the return of the nth asset will be Given the reduction in the deposit rates of Islamic economy their market substitution into the industry in the physical capital and the rising demand for capital reduces the anticipated capital’s rate of return. The monetary actions are expansionary as it reduces the needed rate of return on the capital and eases the economy in accumulating the physical capital. Due to the flexibility of the deposit rates in Islamic banking, the monetary actions will experience partial offsets. The decline of cash deposits in the economy will make the private sector to shift into currency and physical capital. This will dampen the bank intermediation expansion. Furthermore, the world sector will decline its domestic asset holdings, both the physical capital and deposits of mudarabah, since their return reduces (Siddiqi, 1970). These capital flows will be dependent on elasticity’s of demand functions with reference to rates of return. Thus shifting to a higher flexibility in deposit rate settings is likely to rise to the extent where the monetary policy will be offset. Provided the assets can be substituted imperfectly, the offset will only be partial. Although higher flexibility on the rate of return rises the short term capital flows draws back to monetary, this does not insinuate that Islamic banking adoption will result to a long-run or medium capital outflows. The model is outlined in order to analyze the short term implications of monetary policy. Studying the long-term effects of Islamic banking, one requires to look at the implications that the interest based banking would have on the domestic investments and savings. Conclusion The system process of Islamic economy has various features different from normal economic. The paper focuses on the idea that there are n-assets with no fixed return, and the asset’s rate of return is determined from the real sector return (Azhar, 2010). The Islamic model is presented so that analysis of trade effects in the assets on the economic equilibrium of the system. Therefore, the assets that can survive in that economy are those representing the claims of ownership to the real capital. A single asset that satisfied the requirement of Islam is the equity share in terms of common stock. The Debreu model assumes that the equity shares can be traded on an international level. More emphasis is placed on the real sector development to determine how the ROR in the sector will determine the equilibrium in the system without assuming the fixed interest rate. The long-run conditions of the equilibrium are gotten from the closed economy (Ahmed, 2008). Generally, the capital flows direction depend on the difference existing between the foreign and domestic RoR on the equity shares and on the MPK differentials, Additionally, it is shown that trading of goods has no affect the stability and equilibrium of the Islamic economy, rather when the equity trade is allowed. Therefore, when the interest bearing assets is not there, the macroeconomic analysis will not be hampered in the model. A standard analysis can be performed to find the conditions which need to exist for economies that are non-interest in reaching the equilibrium. The model of Arrow-Debreu was all about risk sharing in an optimal manner in an open economy. It tackles how good risk can be allocated in the economy. It assumes that risk need to be allocated in economies that handle the risk. It assumes that the contracts and the markets are complete. It further envisions that the exchange process requires various virtues (Siddiqi & Nairobi, 1985). Reference Ahmed, M. M. (2008). Islamic economy. New Delhi, India: Anmol Publications. Azhar, R. A. (2010). Economics of an Islamic economy. Leiden: Brill. Benigno, G., & Beningo, P. (2001). Price stability as Nash equilibrium in monetary open economy models. New York: Centre for Economic Policy Research. Ganelli, G., & Lane, P. R. (2002). Dynamic general equilibrium analysis: the open economy dimension. London: Centre for Economic Policy Research. Grinols, E. L., & Turnovsky, S. J. (1991). Stochastic equilibrium and exchange rate determination in a small open economy with risk averse optimizing agents. Cambridge, MA: National Bureau of Economic Research. Grohe, S., & Uribe, M. (2002). Closing small open economy models. Cambridge, MA.: National Bureau of Economic Research. Iqbal, M. (1988). Distributive justice and need fulfilment in an Islamic economy (Rev. ed.). Islamabad: International Institute of Islamic Economics, International Islamic University ;. Konnov, I. (2007). Equilibrium models and variational inequalities. Amsterdam: Elsevier. Masters, B. A. (1988). The origins of western economic dominance in the Middle East: mercantilism and the Islamic economy in Aleppo, 1600-1750. New York: New York University Press. Mirakhor, A., & Zaidi, I. M. (1988). Stabilization and growth in an open Islamic economy. Washington, D.C.: International Monetary Fund. Naqvi, S. N. (1982). On replacing the institution of interest in a dynamic Islamic economy Syed Nawab Haider Naqvi.. Islamabad: Pakistan Institute of Development Economics. Qaḥf, M. M. (1978). The Islamic economy: analytical study of the functioning of the Islamic economic system. Plainfield, Ind.: Muslim Students Association of U.S. and Canada. Siddiqi, M. N. (1970). Some aspects of the Islamic economy ([1st ed.). Lahore: Islamic Publications. Siddiqi, M. N., & Nairobi, K. (1985). Insurance in an Islamic economy. Leicester: Islamic Foundation. Warde, I. (2010). Islamic finance in the global economy (2nd ed.). Edinburgh: Edinburgh University Press. Read More

This endeavor, apart from its interest, it clarifies the relationship between the real sector and the financial industry in Islamic economy. Specifically, the evaluation is done on the canals where the monetary policy changes the rate of return on the real and financial assets, hence affecting the output, balance of payment, and output. The paper discusses the equilibrium model for the Islamic economy. The model illustrates how the changes in the holding of the government will affect the rate of return and how the substitution of the assets affects the monetary policy outcome.

It further presents the relationship between savings and investments an Islamic economy and the account deficit. The last section of the paper discusses the concluding remarks. Stability and Equilibrium in Islamic economy Model Using the Arrow Debreu type of model it can be outlined to what degree the stability and equilibrium conditions will be affected when the interest do not exist in the Islamic economy as capital price. This means specifying a pricing technique to convert a product in a single period to similar commodity in another time.

It is assumed that uncertainty is absent, real products can be exchanged through monetary means as medium of exchange and no commodity can be exchanged for similar products. When there is no interest, the existence of stability, and equilibrium of Arrow-Debreu model. It is also argued that the assumption of uncertainty can be removed without implicating the model. Risk is taken as a product that has price termed as the profit. An important assumption is that time has no price. Therefore, time pricing only occurs when a product in a single time undergoes exchange for same product in another time.

However, it can be emphasized that Arrow-Debreu model cannot describe the Islamic economy, since market in the Islamic benchmark is not the only exchange institution. Non-market institutions are substantial in Islamic economy and thus cannot be dismissed. The market institutions cannot attain all the goals of the Islamic system but only achieves efficiency. This should be brought into focus that studying general equilibrium in the economy needs a different benchmark that is yet to be developed.

Therefore the model can be summarized using the following assumptions The Islamic economy The equation satisfies the above assumptions. The Arrow-Debreu for the Islamic economy equilibrium will be  The expression will satisfy: J=1,…….., J, y, Arg max  For all  And when  For every  Analyzing the consequences of the economy to trade in assets and goods can easily be simplified and modified. Money is added as an asset having a zero nominal return. The retained earnings can be dismissed through assumptions that shares in an economy is equal to using the earnings to purchase shares in the company.

The share number is equal to capital goods; E=K, the aggregate supply is taken to be a capital function The rate of return is taken to be r=dFP/Pe P is taken to be the price level, while Pe is the shares nominal price, dFP is the marginal product of K. when the prices of shares are defined,  The rate of return will be  The capital gain and profits will be  Hence  Real wealth is defined as  where m is the real balances stock. The demand equations for the assets (good, equity, and money) will have The equilibrium in goods, money, and equity shares markets are given by Q is taken to be the aggregate supply, PL is money demand in nominal terms.

 From the above equation, stability can be determined when y=AD, E=K and I is 0. The conditions can only be met when m=m*, k=k*, and r=r*. Assuming the price is P, then the exchange rate will be  While focusing on the good’s trade, the short-equilibrium will be attained as below where T= Trade Balance. The following differential equation determines the adjustment process’ dynamic structure .. Allowing trading of assets and goods, the short-run equilibrium will become When the return payment on the foreign holding of the domestic equities is done, y=F(K)-F*iEf, will modify the above equations to form 43.

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