Relative stability of interest-free economy

Abstract EN

Islamic financial facilities like profit and loss sharing (PLS) are flexible enough to provide built-in stabilizers to the investment process.

The amplitude of all phases of the business cycle will be smaller in an Islamic economy compared to advanced capitalist economies where the fixity of the fluctuating short term interest rates account for the unstable and cyclical behaviour of investment.

This is demonstrated by emphasising the dependence of investment decisions on financing and capital valuation (following Gordon, Tobin, and Minsky) then using a qualitative model of two differenttial equations to express financing conditions and investment behaviour.

PLS financing makes payment commitments a function of cash flows and strongly discourages the financing of speculative borrowers - thus, eliminating the main sources of volatility in capitalist economies.