Date of Award

Winter 1985

Project Type


Program or Major


Degree Name

Doctor of Philosophy


Until recently, practically all Muslim economies followed economic practices which contained elements alien to Islam. One alien factor is the practice of taking of interest in spite of its prohibition by Qur'an, the holy scripture. The issue of interest has been at the forefront of controversy in the Muslim economies since independence from foreign powers. Islamic scholars unanimously support the organization of the financial institutions on the basis of modaraba, a form of sleeping partnership. In modarabas, entrepreneurs and financiers agree on a profit-sharing ratio to share profits which replaces an interest rate. Interest-free financial institutions, based on modarabas, are operating among the occidental financial institutions in several countries. There are some countries such as Iran, Pakistan and Sudan who have adopted a completely interest-free financial system.

The macroeconomic models employed for planning and development needs are interest-oriented developed by Classical and Keynesian economists. Obviously the macroeconomic models are not applicable in the interest-free economies and there is a need to develop models consistent with the interest-free financing.

This study modifies a representative Western model into an equivalent interest-free model by incorporating an interest-free financial system. The interest-free model is analyzed to determine effects of fiscal and monetary actions. In addition, development prospects of the interest-free financing and the interest-based financing are compared for LDCs in inflationary environment.

It is found that profit-sharing ratios play much the same role in an interest-free economy that is played by interest rates in a Western economy so it is possible to manipulate the profit-sharing ratio in an interest-free economy in place of interest-rates to achieve the policy objectives. It is concluded that, ceteris paribus, interest-free system better suits the inflationary LDCs than the occidental system because a closer link is created in investment activity.