Public Finance and Islamic Capital Markets: Theory and Application

PUBLIC FINANCE AND ISLAMIC CAPITAL MARKETS
  • Book Title:
 Public Finance And Islamic Capital Markets
  • Book Author:
Abbas MirakhorObiyathulla ISyed Aun R. Rizvi
  • Total Pages
194
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Conventional Macroeconomic Policy                     

 Since the turn of the century, much discussion has gone into redefining our economic goals and targets. The final decade of the last millennium witnessed many developing countries battling inflation, and succeeding to a great extent in controlling this threat.

Yet this success does not war-rant celebration or a validation of macroeconomic policies as most of the countries failed to achieve stability in their macroeconomic outputs and sustainable growth.

This is in large part because stabilization policies have focused on price stability—even though real stability, as opposed to price stability, is what is ultimately important for attracting investment and achieving sustainable development. The fiscal debts of developing countries at the turn of the last decade stood at a precarious level, threatening world order.

 In the middle of 2016, the once-mighty European monetary union looks vulnerable to a breakdown and even dissolution, owing to the sovereign default of Greece and the near defaults of other European economies.

The obvious reason for this lies in fiscal mismanagement and imprudent macroeconomic policies. The standard macroeconomic policies have come under fire in the recent past for not being able to achieve their stated aims and objectives. This chapter aims to introduce readers to a holistic view of the macroeconomic policies in the conventional framework, and their goals and strategies as defined in literature and practice.

   MACROECONOMIC OBJECTIVES

 Our discussion starts with elaborating on the focus of macroeconomic policymaking from its objective resolution perspective. All economic philosophies argue that the general goal of macroeconomic policy is to maximize long-run societal well-being in an equitable and sustainable manner. Much of the recent discussion in academia and policy corridors has focused on intermediate variables, such as price stability or the balance of payments. However, the question arises whether these intermediate variables are important to delve into or not. Their importance is diminished now, as it is derived largely from their role as possible indicators of economic performance in terms of truly significant variables, such as growth, development and equity.

 The core objectives and focus of macroeconomic policymaking from a long-run perspective theoretically lie in ‘real macroeconomics’ and the use of productive capacity—the employment of capital and labor at their highest potential level—and improvements in that productivity

   Stabilization and Growth

 What matters to the average economic person in the society is the stability and growth of their real income. The question on why growth is the main focus and motivation of an economic person is owing to the critical importance of the long run. Even small changes in the rate of growth have a snowball effect over a period of time. An average growth of real income of 2.5 % to 3 % leads to a significant impact through compounding, and it doubles real-terms income every 28 years at 2.5 % and in 23 years at 3 %.

 Economists have long argued that from fi rms’ economic objectives focus more on overall stability of output and the real economy, not just price stability. This arises out of the fact that high instability generates an ‘unfriendly’ domestic macro-environment that appears to be a crucial fac-tor in explaining low rates of capital formation: fi rms have less incentive to invest, and growth will be lower. An argument which has been proposed in economics suggests that economic policies that lead to fuller utilization of resources today may also lead to higher incomes in the future. This implies that there may be less of a trade-off between growth and stability than orthodox economics implies.

 The question to whether the issues of stabilization and growth can be separated has been explored in economics for decades. In general, it is accepted

that the conduct of short-run stabilization policy has long-term effects. If the economy’s output is lowered 5 % today, the best estimate is that the output path will be 5 % lower than it otherwise would have been fi ve years from now. This has serious implications for economic planners, as it means that most downturns have long-lasting effects, regardless of their causes.

 How to manage stabilization in short run, and what policies are effective? The answer varies from country to country, depending on each one’s experience. Korea and Malaysia’s experience of relying on alternative measures to stabilize the economy, such as the increase in government expen-ditures, has worked effectively. Chile and Malaysia also used regulations on capital infl ows effectively during boom periods in the 1990s. In retrospect, these policies had less adverse effects on long-term growth than relying exclusively on modifying interest rates as the monetarist economic theory suggested at the time. 

   Inflation

 Mainstream economic strategists have long focused on price stability as one of its primary policy objectives, but there exists considerable confusion as to its role. Generally, it is suggested that high infl ation supposedly occurs when the fi scal and monetary authorities in the country are not able to perform their tasks effectively. This leads to a conclusion that it is not inflation which is the main variable of concern, but its importance emerges nonetheless as an indicator of economic malperformance. In the current economic landscape, two major issues have arisen regarding the measure of inflation. Firstly, infl ation has generally been an observer indicator for the policy objective itself. Secondly, the links between infl ation and real variables may be weaker than previously assumed.

 Economic policies have been structured in a manner where there is always a trade-off in deciding which component to choose or to sacrifice. The question arises as to whether the benefits of further reducing infl ation outweigh its costs. Since late 1990’s, most countries have been able to harness inflation, with many countries experiencing relatively low inflation.

When inflation is low or moderate, it has been argued that any effort to further reduce it may have smaller benefits and increasing costs, especially when traditional contractionary monetary policy is the only instrument used to fight it.

 A question that is raised in most inquisitive minds is why is there so much focus on the inflation in macroeconomic policies in the modern day.

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