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Monetary Management in a Dual Banking System: A Nominal-GDP Targeting Approach

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Islamic Finance, Risk-Sharing and Macroeconomic Stability

Abstract

In response to the failure of inflation targeting (IT) to bring macroeconomic stability during the recent crisis, nominal-GDP targeting (NGDPT) has been proposed as an alternative framework for monetary policy. On the other hand, due to the condemnation of riba in Islamic finance, the implementation of a policy rate for monetary management has been faced Shari’ah-compliant challenges. The aim of this paper is to propose NGDPT regime as an efficient monetary policy that is also consistent with Islamic monetary economy. Therefore, we first argue that due to the risk-sharing nature of NGDPT, it is the closest substitution for realizing PLS principles at the macro-level. Then, by applying a canonical DSGE model, the performance of NGDPT in response to various shocks has been compared with that of IT and flexible inflation targeting (FIT). The results show that NGDPT is associated with the lowest volatility of benchmark rate which leads to substantial reduction of output fluctuations and, thus, the improvement of macroeconomic stability. The results imply that NGDPT setting is applicable not only in Islamic banking but also in a dual banking system. In this regard, the adoption of governmental sukuk whose return depends on benchmark rate of NGDPT will help Islamic banks to overcome the problems of liquidity management and fund arbitrage in dual banking systems.

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Notes

  1. 1.

    Other studies include Sumner (1989), Hall and Mankiw (1994), McCalum and Nelson (1999), and Jensen (2002).

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Authors and Affiliations

  1. Department of Economics, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, Tehran, Iran

    Mehdi Hadian

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  1. Mehdi Hadian
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  1. Islamic Research and Training Institute, Islamic Development Bank, Jeddah, Saudi Arabia

    Muhamed Zulkhibri

  2. Islamic Research and Training Institute, Islamic Development Bank, Jeddah, Saudi Arabia

    Turkhan Ali Abdul Manap

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Hadian, M. (2019). Monetary Management in a Dual Banking System: A Nominal-GDP Targeting Approach. In: Zulkhibri, M., Abdul Manap, T. (eds) Islamic Finance, Risk-Sharing and Macroeconomic Stability. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-05225-6_6

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  • DOI: https://doi.org/10.1007/978-3-030-05225-6_6

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