Saving behaviour in an economy without fixed interest
Ul Haque, Nadeem | Mirakhor, Abbas
It has been argued that the Islamic prohibition against an ex ante fixed rate of return on borrowed money will lead to an increase in uncertainty that may reduce savings. In this paper, a model is presented, on the basis of which an unambiguous condition is derived that must be satisfied if, in the face of variation in riskiness and the rate of return, savings are to decline. This condition requires that the rate of return when risk is present must be no more than the rate of return when risk is absent. It is suggested that the structural changes accompanying the adoption and implementation of an Islamic financial system may produce favorable effects on the rate of return. More importantly, the derived condition suggests that a priori assertions that the elimination of interest will reduce savings may not be justified without sufficiently strong reasons to believe that the rate of return will also not increase. A stronger conclusion might be derived if the effects of structural changes and adoption of Islamic rules of behavior on the rate of return were taken into account.
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