Introduction

Foundations of interest-free monetary policy and review of recent literature

The model

Interest-free monetary policy and the aggregate expenditure function

Interest-free monetary policy and macroeconomic equilibrium

Theoretical foundation of interest-free monetary policy and its impact on reducing both inflation and unemployment rates

Rightward shift in the aggregate supply curve

Evidence from 23 developed capitalist countries on mean differences in misery index between interest-based monetary policy (Group X) and interestfree monetary policy (Group Y) countries

Statistical test of mean differences between Group X and Group Y

Conclusion

References

Abstract

Purpose – This paper aims to examine the effects of interest-free and interest-based monetary policy on inflation and unemployment rates for two groups of countries where in one group, interest-free monetary policy (IFMP) was pursued, while in the other group, interest-based monetary policy (IBMP) was followed. Design/methodology/approach – This study involves a sample of 23 developed countries divided into two groups. The authors measure economic performance by misery index (MI), and MI is calculated as unemployment rate plus inflation rate. A group of countries, where MI is lower, performs better compared to the other group where MI is relatively higher.
Findings – The results reveal that in group of 12 countries where IFMP is adopted, the MI is lower and thus performs better compared to a group of countries where IBMP is pursued.
Research limitations/implications – The findings of this study have profound implications for the policymakers and government leaders who look for a solution to maintain both low inflation and unemployment rates. The findings in this study clearly portray that such ideal situations can only be achieved by pursuing IFMP. No wonder the countries which have been historically pursuing IFMP such as Japan, Switzerland, Sweden, the Netherlands and Denmark have been able to contain both inflation and unemployment rates compared to their counterparts among the English-speaking countries.
Originality/value – This is one of the most recent tests on the differences in economic performance between IFMP and IBMP. These results have significant value for policymakers and central bankers who have been struggling to maintain lower MI for decades.

Introduction

For over a year, Eurozone countries have pursued an interest-free monetary policy (IFMP). Some Organisation for Economic Co-operation and Development (OECD) countries such as Japan, Denmark, Sweden and Switzerland went even further and followed negative central bank (CB) interest rates (see sources of CB interest rates), while other OECD countries pursued positive bank rates. The decision to follow negative interest or IFMP is a new development for these Eurozone countries plus another five prominent OECD members, most of which are developed capitalist countries. IFMP, or interest-free banking, has its roots in the divine revelations of the Qurʾ
an, the words of Allah (may He be exalted), and the traditions (
hadīth) of Prophet Muhammad (peace be upon him). As such, an interest-free economic system has profound and positive impacts on investment spending, consumption spending and aggregate expenditures, all of which in turn increase output, employment and income. An increase in output eliminates shortages and excess demand and thereby stabilises the price level. In addition, IFMP lowers the overall costs of financing, resulting in a rightward shift of the aggregate supply curve, and thereby increases real gross domestic product (GDP) and reduces the price level. An increase in real GDP increases employment and decreases the unemployment rate. The reduction in the price level caused by the rightward shift in the aggregate supply curve decreases the inflation rate.