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Introduction to Islamic Economics: Theory and Application by Abbas Mirakhor, Zamir Iqbal, Hossein Askari

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Chapter 7Macroeconomic Equilibrium: Characteristics of an Islamic Economy1

  1. The prohibition of fixed interest-bearing debt instruments and economic management.
  2. Islamic-endorsed assets and the needed range of financial instruments for macroeconomic analysis.
  3. In the Islamic system, the return on financial instruments and its link to the real sector.
  4. In the Islamic system, the link between the real and the financial sectors and its one-to-one mapping.
  5. Stable economic equilibrium without interest-bearing debt instruments.

In an Islamic financial system, all financial arrangements are based on sharing risk and return. Hence, all financial assets are contingent claims, and there are no debt instruments with fixed and/or predetermined rates of return. This characteristic makes the Islamic model ripe for the application of an Arrow-Debru-Diamond type analysis of a stock market economy under uncertainty. A fundamental principle that emerges from theoretical studies of such a system is that the returns to financial assets are primarily determined by the rate of return in the real sector. This principle implies that the rate of return of capital is the mechanism through which the demand and supply of lendable funds is equilibrated. This follows from the fact that the source of profit in such an economy is the addition to total output. Once the labor is paid its distributive share, the residual is then divided between the entrepreneur and the investor (saver). Since ...

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