A Macroeconomic Model of Interest-free and Open Economies An Empirical Analysis for Sudan Economy (1990 - 2004)

Abstract

This thesis attempts to develop an interest-free Islamic general equilibrium macroeconomic model from the familiar classical and Keynesian macroeconomic models. It aims to investigate the possibility of utilizing Islamic doctrine to present an open macroeconomic model of interest free financial instruments to replace the interest based models, nowadays prevailing in almost the majority of the Muslim countries. It further aims to investigate its superiority over the classical interest based model and to evaluate Sudan's experience in Islamization of its economy. The research problem lies in the fact that, the adoption of the borrowed interest bearing economic systems in Muslim countries is one of the reasons that, most of them remain among the less developing countries of the World. Thus the main hypothesis of this study is that, Islamic doctrine is able to present an open macroeconomic model of interest free financial instruments that can be developed from the familiar classical and Keynesian models. Also to test the hypotheses that, interest is one of the main obstacles in promoting investment , foreign trade development and achievement of economic development and the hypothesis that the real rates of return of savers and investors will be preserved during inflationary and deflationary periods in the interest free Islamic economies. To achieve these purposes, an inductive method has been adopted where the interest rate has been replaced by the profit sharing ratio at the micro level while the analysis has been carried through to the macroeconomic level. Econometric method has been used when the developed model was applied to Sudan's economy over the period (1990-2004) in order to evaluate the Sudan's experience in Islamization.Mathematical deductive method has been used through which the behavior of the developed model had been analyzed to predict its response to fiscal, Monetary and exchange rate policies under two approaches: flexible exchange rate and the fixed exchange rate approach. Thus the main findings of the Islamic model within the context of these approaches are: The effect of the expansionary fiscal policy on the aggregate variables under the two approaches and the response of both the expansionary monetary policy (under the flexible exchange rate during inflation) and the restrictive monetary policy (during deflation) have resulted in an improvement in both capital and trade balances and consequently the balance of payments had improved. On the other hand, during deflation, expansionary monetary policy will give opposite results to those of the expansionary fiscal policy. Expansionary monetary policy under fixed exchange rate system and inflation will result in a temporary effect that will disappear in the long run.The restrictive monetary policy under a fixed exchange rate and inflation has shown an inconsistent result.It is concluded that fiscal and monetary policies under a fixed exchange rate should be used together in order to achieve the targeted goals of full employment and balanced balance of payments. With regard to the effect of inflation on the interest free economy, it is concluded that both savers' and investors' real returns have been preserved during inflationary and deflationary periods which is conducive to successful and permanent development. Devaluation results revealed that the effects of devaluation on the macroeconomic variables in this model are similar to those of the interest bearing model. Also the study findings showed that interest (riba) rate has been one of the main factors that led to Global financial crises. {2SLS} and {ILS} techniques had been applied to estimate the model equations. The estimation results have shown that most of the parameters of the equations of the model are significant and consistent with econometric theory. Ultimately historical simulation had been conducted to test the validity of the estimated model. Forecasting results are reasonable and the predicted performance of the model has been fit to some extend. Finally the study concludes with a summary and recommendations in which both Muslim and Non-Muslim countries are recommended to switch to the Islamic interest-free financing system so as to avoid global financial crises , ensure just returns to both investors an savers during inflationary and deflationary periods , and consequently achieve and preserve economic development particularly Muslim countries. Also the establishment of professional Islamic economic centers for further research and studies in quantitative macroeconomic modeling are recommended