MONEY, INTEREST AND AN ALTERNATIVE MACROECONOMIC SYSTEM

Abstract

This paper discusses the peculiar nature of money, and how the introduction of interest-based financing disturbs the essential function of money and causes economic instability. An alternative system based on profit-sharing is proposed. It is shown that the profit-sharing system may lead to a higher level of investment and consumption and thus provide for greater economic stability. The alternative banking system can extend zero-interest consumer loans that would lead to higher consumption levels and lower general price levels. A central bank shall auction money supply on the basis of profit-sharing with competing banks. The sovereign profit share replaces the discount rate in regulating money supply. Some alternative forms of "rediscounting" and open market operations are suggested. The nature and role of money is one of the most controversial subjects debated by economists. There is almost a unanimous agreement among economists about the monetary sources of economic instability, yet the differences of opinion are basically about the line of causality of such instability. For monetarists, the problem lies with the abrupt changes in the quantity of money, while for the Keynesians, it lies with instability of the money demand function itself. The purpose of this paper is to review the sources of instability and propose an alternative financial system to resolve it. The first section is "On Money and Interest," the second is about "The Modern Financial System and How it Relates to the Real sector," the third is about "The Alternative System" and the fourth is the Conclusion.

JEL classification: E40, E50, Z12

Key words: Money, Instability, Islamic economics