THE ROLE OF MONETARY POLICY IN DINAR SYSTEM (The issues and existence of monetary instruments) Nuradli Ridzwan Shah Mohd Dali 1 Lecturer, Universiti Tenaga Nasional Kampus Sultan Haji Ahmad Shah 26700 Pahang Tel: 09-4552028 Fax: 09-4552020 nuradli@kms.uniten.edu.my Muhammad Rubini Kertapati 2 Faculty of Business and Economics University Kebangsaan Malaysia 43600 Bangi, Selangor Tel: 016-2518987 Bibin_1996@yahoo.com ABSTRACS The issue of monetary policy in terms of macroeconomic is a never-ending debatable issue. The main objectives of the monetary policy are to maintain price stability, low inflation and full employment. Explicitly, the objective is to achieve and maintain exchange rate stability as a monetary policy target. The term of exchange rate stability could be different, that is in term of internal stability-the price stability (stable in terms of prices of goods and services) or external stability - (stable in terms of prices of other currencies). In the other side, many Islamic scholars postulate that if we introduce Dinar to replace fiat money, there will be stability in price. If the price stability in the Dinar system could be achieved from the implementation of the gold currency itself, the existing monetary policy seems impotent in the Dinar system. This exploratory research try to answer using theoretical views on several questions such as the relevancy of taking the objective of price stability as in the conventional economy to the Dinar system; the monetary instruments in Dinar system and the mechanism transmission in Dinar system. The analysis will be using the improvised IS-LM in an open economy. Keywords: Dinar, Monetary Policy, Inflation 1 The author is a PhD scholar at the Faculty of Business & Economics, Universiti Kebangsaan Malaysia. 2 The author is a master scholar at the Faculty of Business & Economics, Universiti Kebangsaan Malaysia.
1. Introduction The Implementation of Gold Dinar Gold Dinar and Silver Dirham were once used as mediums of exchange since the Byzantium era until 18 th century by Sasan people, the empire of Islam and western world before the colonialization process took part and replaced the bimetallic currencies with fiat money or paper money. The bimetallic currencies have intrinsic values and their measurements were based on its weight and quality of the composition of the currencies. In contrast, the current fiat money does not have intrinsic value but depends on token value. The survival of the fiat money depends on the trust and faith of the society that the fiat money has value and good for daily trade transactions. Failure in maintaining the public faith in its value will jeopardize the overall economic system making the fiat money worthless. The current fiat money system is not backed by any commodity such as gold, silver or any stable commodities. The Gold standard which was adopted in England in 1821 was an example of fiat money backed by gold. However the gold standard was abandoned in 1913 as stated out by Bordo (1999) and 1914 by Eiteman at el (1995). There are two major advantages of the gold standard system, the first advantage was it imposed a command standard of value on all national currencies. This had brought a measure of stability to international trade and investment and also stabilized exchange rate fluctuations. Second advantage was it could create an economic discipline where by tying currencies to gold, the nation could regulate the growth and stability of its economies (Rose, 1994). However, due to the expanding volume of international trade and the limited supply of gold, the Bretton Wood system was in 1935. The main concept of this system was the linking of foreign currency prices to the US dollar and to gold. Thus, from 1935 to 1968, foreign countries could redeem dollars in their possession for US gold at the rate of $35 per ounce. The success of this new price or this new system depended heavily on the ability of the US to maintain confidence in the dollar and to protect its value. However this system failed in 1971 when Nixon administration devalued the US Dollar and suspended the convertibility of dollar to gold (Rose 1994). This led to the floating rate regime whereby the currencies are floated and were not backed by gold or commodities. The currencies in this system are open to speculative menace, which led to the Asian currency crisis in 1997. Mahathir Mohamad, former Malaysian Prime Minister has mooted the idea of Gold Dinar to be used as international payment settlement between OIC
countries in Qatar 2002. The idea is to mitigate the currency risk and to avoid the currency speculation effects and to reduce dependency to the US Dollar even though implementing the Dinar side by side with fiat money will not end the speculation activities entirely (Mohd Dali, Mat Husin, Mohd Yusuf, 2002). The idea is to build a trading bloc for the OIC countries as the European Union with their success in implementing the Euro currency. The implementation of Dinar is a symbol of unity of the OIC countries not only in issues matters pertaining to political issues but also to global business environment. The bondage of Dinar among of the OIC countries could strengthen the economic conditions of the member countries. In the idea the existing fiat money will not be replaced entirely but will be used for domestic uses and the gold Dinar will be used for international trade settlement purposes only. The usage of gold Dinar is confined for international trade only mainly due for precautionary and unity purposes such as to avoid economic un-stability if the fiat money is replaced entirely, to promote trade among the OIC countries and as a level of platform for the unity of OIC countries and to avoid massive disrupts of one economy as the demand of gold increase, the price of gold will increase and since the gold price is almost perfectly negative correlated with currencies, the currencies exchange of paper money will depreciate in value (Mohd Dali & Mat Husin, 2004 (a)). a. Issues in Monetary Policy i. Objectives of monetary policy ii. Central banks as the agent of monetary policy iii. Issues arises from the implementation of gold Dinar One of the most extreme arguments of the Gold Dinar economy is the power of the central banks in using money supply growth via credit creation and increase in money supply is disabled. The roles of the central banks become agents of payments and developmental role and as the custodian of external reserves. Now the issue is whether is there any mechanism that the central bank could use since the power to print money and to increase or decrease interest rate are eliminated in Dinar economy, which promote currency with intrinsic values and promote interest free economy or riba free economy. Mohamad Nor Yakcop (2002) states that the roles of central bank in the dinar economy are listed as follows: a) Developmental roles of central banks b) Roles as payment agents c) Roles as custodian of external reserves. (Yakcop, 2002)
2. Literature Review 3. Objectives of the research 4. Theoretical framework a. Based on IS-LM (Td) b. Assumptions of the model i. Open economy ii. Dinar will be used as the medium of exchange instead of paper money. iii. Central banks function will be intermediary for international settlement, custodian for external reserve and developmental roles only. iv. Dinar could not be created and compounded at will as fiat money. v. Free interest economy vi. Money multiplier is not possible vii. Price is stable. viii. A dinar in home and foreign country has same value and weight, Y = C + I + G + (X-M) = C + S + T + Rf Y = I (Td) + G + X (HC, TC) = S(y-t(y)) + T(y) + M (y) + Rf Figure 4.1: The Derivation of IS(Td) Curve S+t i+g E0 E1 S+t I 1+g I 0+g Y Td IS E 2 E 1 Y
Figure 4.2: Derivation of LM(Td) Curve Td Ms M0 M Td Lm2 Lm0 Lm1 Y2 Y0 Y1 Yo = If Td surplus is 0 Y1= If Td is a surplus Y2=If Td is a deficit Y 5. Conclusion & Implication
Reference Bordo, Michael D. The Gold Standard and Related Regimes. Cambridge University Press. 1999. Eiteman et al. Multinational Business Finance. 7 th Edition Addison Wesley Publishing Company Inc. 1995 Mohd Dali, Nuradli Ridzwan Shah at el. The Implementation of Gold Dinar. Is It The End of Speculative Measures? Journal of Economic Cooperation SESTRCIC, Ankara Turkey. July 2002. Mohd Dali, Nuradli Ridzwan Shah & Mat Husin, Norhayati (a). Gold Dinar. The Impacts On Consumerism Towards Creating A New Islamic Economy Procc of the Second Economics Colloquium Organized by Department of Economics University of Technology Mara, Johor Branch on 24 Mei 2004 at Golden Legacy Hotel, Malacca