This document discusses the flaws in mainstream monetary economics theories and policies like inflation targeting. It argues that monetary policies focused only on aggregate inflation are meaningless and ignore important factors like relative price movements between goods. Interest rate increases aimed at reducing inflation can actually increase prices according to some historical theories. The document also notes that monetary policy actions like interest rate hikes reduce demand and increase unemployment. As an alternative, it promotes Islamic finance tools like Salam that could achieve monetary policy goals while benefiting people more directly.
This document discusses the flaws in mainstream monetary economics theories and policies like inflation targeting. It argues that monetary policies focused only on aggregate inflation are meaningless and ignore important factors like relative price movements between goods. Interest rate increases aimed at reducing inflation can actually increase prices according to some historical theories. The document also notes that monetary policy actions like interest rate hikes reduce demand and increase unemployment. As an alternative, it promotes Islamic finance tools like Salam that could achieve monetary policy goals while benefiting people more directly.
This document discusses the flaws in mainstream monetary economics theories and policies like inflation targeting. It argues that monetary policies focused only on aggregate inflation are meaningless and ignore important factors like relative price movements between goods. Interest rate increases aimed at reducing inflation can actually increase prices according to some historical theories. The document also notes that monetary policy actions like interest rate hikes reduce demand and increase unemployment. As an alternative, it promotes Islamic finance tools like Salam that could achieve monetary policy goals while benefiting people more directly.
Minhaj University, Lahore COMMENTARY ON CONTEMPORARY MONETARY POLICY The mainstream monetary economics is filled with contradictions, logical inconsistencies, missed and messed normative implications and data inconsistencies. There are heterodox theories having better match with historical data, but the theories are often undermined and ignored. It is in fact difficult to find something logical and valid in classical monetary economics. Despite a clear empirical failure, monetary economics is still widely believed which is quite surprising. LOGICAL INCONSISTENCIES Any real implication of inflation on the economy comes from relative price movement. If prices of all goods and services increase at the same rate, no real variable would be affected E.g. Phillips curve assumes that inflation affects employment It happens due to differential in the changes for wages and commodity prices. This means, focusing aggregate inflation is meaningless. One needs to look at the relative movement of sub-indices of the consumer price index. But the monetary policy especially the inflation targeting framework explicitly focuses on aggregate price level without taking any care of the relative price movement. MISSED AND MESSED NORMATIVE IMPLICATIONS. Assume increasing interest rate reduces inflation. The demand for necessities cannot be reduced significantly. Therefore, if any reduction in price level occurs, it must be driven by prices of luxuries. Therefore, the rise in interest rate will improve the purchasing power of consumers of luxuries, and would be ineffective to improve the prices of necessities. There are very obvious normative implications, which are never discussed MISSED AND MESSED NORMATIVE IMPLICATIONS Assume that increase in interest rate reduces the prices. The demand channel also implies that a higher interest rate leads to increase in unemployment. Therefore, the cost of price stability is loss of jobs Those who are at the risk of losing jobs are the poorest people. Therefore price stability comes at the cost of the most vulnerable cohort of society IGNORING FACTS Thomas Tooke (1773-1858) is perhaps the first person to produce a book in monetary economics. He is also a pioneer of the ‘Banking School theory’. This theory predicts that higher interest rates lead to higher prices Simple logic: the interest rate is a part of cost of production, higher cost, higher prices This is the oldest theory on the relationship between interest rate and inflation Never mentioned in the economic textbooks and even top economists don’t know about it DENYING FACTS Gibson (1923) finds that higher interest rate leads to higher prices It was termed as Gibson Paradox to reflect absence of theory Theory exists from the day 1 DATA INCONSISTENCY The facts are often ignored in Monetary economics After June 2021, more than120 countries increased interest rate with aim to control inflation The countries successful to control inflation are less than 10 This means a failure; yet it is practiced IT’S HARMFUL Pakistan pays 4000 billion in markup Its not price of borrowing, its price of inflation control Yet inflation is also out of control It is wasting half of national budget to achieve nothing Even flood victims are suffering and no money for them, banks get hundreds of billion after every MPC meeting OBJECTIVES OF MONETARY POLICY Growth Employment Price Stability Financial Stability
All an be achieved by Salam; isn’t it?
ISLAMIC ALTERNATIVE; SALAM It can be used for monetary injections/ mop-ups It can be used for inflation control It can be used for all other objectives that monetary poliy tries to achieve ADDITIONAL ADVANTAGES Monetary policy works through bankers, they are primary beneficiaries Salam would benefit the grass-root level at first It is best alternative of interest based microfinance, even better than Qarde Hassan If you give Qardhe Hassan for agriculture, you will get back money Farmers have skills in production, not in marketing This may result in default In salam, the farmer pays you the product That means he will use energy for production Thank you