Nominal interest ratesinclude all three risk factors, plus the time value
of the money itself.Real interest ratesinclude only the systemic and regula-
tory risks and are meant to measure the time value of money. Thereal rate
is equal to thenominal rateminusinflationand minuscurrency adjustment.
Thereal interest ratein an economy is often the rate of return on a risk-
free investment, such as U.S. Treasury notes, minus an index of inflation,
such as theConsumer Price Index(CPI) orGross Domestic Products Defla-
tor(GDP Deflator). This is what we can call the interest rate decided by the
Fed, as explained earlier, to run its fiat money policy to the best of its abil-
ity. It must be stated that no specific money system is being advocated here,
because that is not the subject of this book nor of the RF banking and
finance system presented here. All we want to achieve is to familiarize the
reader with the fact that the interest rate set by the Fed is in fact a policy
tool and it is, in simple layman’s terms, a mechanism by which the govern-
ment decides how much money to print or to withdraw from the market in
order to achieve its policy goals about inflation, prices, and employment
levels.
As suggested by the equation, if all is kept constant and the FOMC
wanted to increase the economic production, they would reduce the short-
term interest rate on Fed Funds, and increase the rate if the opposite were
true. Of course, real life situations are more sophisticated and involve many
other scenarios, permutations, and parameters. However, the fact remains
that the interest rate that the Feds use is different from the one prohibited in
Shari’aa. It is a calibration tool that adjusts the flow of money in or out of
the fiat paper money system.
All those who believe in Judeo-Christian-Islamic values should focus on
two important factors in our development of the RF banking and finance
system. These factors are:
&The use of thecommodity indexation ruleand approach to ensure fair
market pricing, as was discussed earlier and will be further developed
later in the book.
&The use of themarking-to-marketconcept to make certain that we are
renting tangible and rentable assets, and not money, in order to ensure
that we are investing prudently.Fiat (Paper) Money and the Cyclical Nature
of the Fiat Money Economy
Professor Ahmad Kamal Meera^17 authored an interesting book on the eco-
nomics of fiat money, bank fractional reserves, and interest, in which he
concluded that the fiat money interest-based system causes asset bubbles,
particularly after the potentialGDP levels of an economy have been
102 THE ART OF ISLAMIC BANKING AND FINANCE