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Islamic Monetary Economics and Institutions pp 55–64Cite as

On Normative and Logical Foundations of Monetary Policy

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Abstract

The monetary policy today has literally become interest rate policy. The central banks decide the short-term interest rate to achieve their objectives. The monetary policy is conducted without considering any socioeconomic and ethical implication of its use. However, in reality, the monetary policy has several socioeconomic, moral, and ethical implications. For example, the conduct of monetary policy is based on the assumption of demand channel of monetary transmission mechanism. This channel assumes that by increasing the interest rate, the aggregate demand in the economy could be reduced which will put downward pressure on the aggregate price level. Suppose the demand channel works and the aggregate demand could be reduced by increasing interest rate, it is quite clear that such a reduction in demand can occur mainly due to luxuries, and, therefore, the price of luxuries shall reduce. The consumption of necessities could not be reduced reasonably by the change in interest rate; therefore the prices of necessities are also unlikely to reduce, and the monetary intervention would increase real income of consumer of luxuries relative to those having necessities in their consumption basket, leading to a redistribution of real income which favors privileged class of society. There are many other ways in which the monetary policy can affect the socioeconomic variables. This chapter summarizes number of logical flaws and socioeconomic consequences of the monetary policy which show that monetary policy should not be conducted without analyzing its socioeconomic consequences.

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Authors and Affiliations

  1. Department of Econometrics and Statistics, Pakistan Institute of Development Economics, QAU Campus, Islamabad, Pakistan

    Atiq-ur-Rehman

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  1. Atiq-ur-Rehman
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Correspondence to Atiq-ur-Rehman .

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Editors and Affiliations

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

    Muhamed Zulkhibri

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

    Turkhan Ali Abdul Manap

  3. Maldives Centre for Islamic Finance, Haveeree Hingu, Maldives

    Aishath Muneeza

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Atiq-ur-Rehman (2019). On Normative and Logical Foundations of Monetary Policy. In: Zulkhibri, M., Abdul Manap, T., Muneeza, A. (eds) Islamic Monetary Economics and Institutions. Springer, Cham. https://doi.org/10.1007/978-3-030-24005-9_4

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