Stabilization and Growth in an Open Islamic Economy

Abstract

Islam proposes the replacement of an interest-based financial system with one which operates on the basis of risk and profit sharing. Using a general equilibrium model, the paper investigates some open-economy implications of adopting Islamic banking for economic growth and stabilization. It analyzes the long-run effects of Islamic banking on international capital flows and on the economy's capacity to adjust to disturbances. It concludes that monetary policy can be used effectively for stabilization purposes and that disturbances to asset positions are absorbed efficiently in an Islamic financial system.

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