The Art of Islamic Banking and Finance: Tools and Techniques for Community-Based Banking

scenario might call for a different weighting—such as, for example, the allo-
cation of 70 percent for inflation and 30 percent for GDP, or vice versa. This
will depend on the situation, the country involved, and the strategic options
available to the central bankers. It is important to clarify further that the
interest rate component of the equation is a mere rate or percentage; it is
conceptually and materially different from the usury (price charged for using
money) or interest (the price for renting money). In this context, this rate is
in fact a percentage rate that influences the rate at which fiat—money—
should be grown (by printing more) or shrunk (by selling government bonds
at high rates to absorb the excess liquidity, or by increasing the reserve re-
quirements of the banks). The equation suggested can be written as follows:

Target ShortTerm Fed Funds Interest Rate¼Rate of Inflation as measured

by GDP deflatorþEquilibrium Real Interest Rateðdefined approximately

as prevailing interest rate minus inflationÞþan Inflation Contribution

þan Economic Growth Rate Economic OutputðÞContribution

Please see the definitions of the components of the Taylor formula.

Rate of Inflation: As defined by a basket of products and services in

the economy.

Equilibrium Real Interest Rate: Interest rate charged by banks and

financial institutions minus inflation rate (approximately).

The interest rate charged by banks and financial institutions to

their customers is in fact the riba we are talking about; it is prohibited

in the Judeo-Christian-Islamic value system because it conceptually rep-

resents paying a price for the use or rental of money. This rate, as we

discussed in Chapter 3 and will discuss in more detail later, should be

obtained using the mark-to-market rule, not the rental rate of money.

Inflation Contribution: A percentage of theinflation gap, defined as

Current Inflation Rate minus Target Inflation Rate, as defined by poli-

cymakers. Taylor suggested that we give it a 50 percent weight. How-

ever, one can give it a different weight depending on monetary policy

goals and strategies.

100 THE ART OF ISLAMIC BANKING AND FINANCE