Week 3 Reading: Just Money

The manipulation of interest rates is a part of monetary policy. The rate is set by the Central Bank of England, who can manipulate the interest rate in order to influence economic activity in a country. There are several reasons why the central bank manipulate interest rates for example: if the economy is experiencing high levels of aggregate demand that is anticipated to lead to an increase in inflation above the target (2%) the central bank will potentially increase interest rates. This will lead to a decrease in consumption and an increase in saving because people will want to save more money due to the increase in reward. The increase in rates will result in a decrease in borrowing and therefore investment: the cost of borrowing will increase as interest rates go up. The diagram below illustrates this. As interest rates increase, there is a leftward shift in Aggregate demand, from AD1 TO AD2 resulting in a reduction of the price level from P1 to P2.

When borrowing money, the rate of interest on that, or in other words "the price of money" is decided by the Bank. This is unlike the price one would pay for a good such as a tomato - where the price is fixed and depends upon the Law of Supply and Demand. Also unlike a tomato, with credit there is no challenge having to account for wages of labor or land in order to produce it. The act of credit creation is therefore "effortless" meaning there is no limit to the volume of credit that can be created. The threat of this however is that this could lead to excessive credit lending which can lead to inflation, or a contraction in credit lending which can lead to deflation. 

This banking system however has led to the "extraction of wealth" from borrowers. By doing so has contributed to the increased gap between the wealthy and the poor. Here, the poor become even poorer they owe more debt if they cannot pay it back in time, and so potentially borrow more credit in order to pay back the original debt.

Usury today in the western world is accepted as normal, as "western economies that have been weekended, morally, politically and economically by the parasitic grasp of finance capital...". I actually found the above quote quite funny because it's unusual to see such a strong and well-worded negative opinion of a financial system, in a factual textbook. Hahaahhahahhhahahhaaa

Usury is haram (forbidden) in Islam because money should only be used as a medium of exchangeor "way of defining the value of a thing", therefore money is not supposed to have value in itself. It would be interesting to know how Muslims living in Western society get around using Western economic systems where usury is rife. 

I looked a little into how Islamic banks work if they are forbidden from charging interest. 

"An Islamic bank also lends money to people. But it is kind of a business agreement between the bank and the borrower. The borrower will run the business while bank will look over. The profit of that business will be shared between the bank and the borrower in a prefixed rate documented earlier in the agreement. Islamic bank also provide services and charge money."

It seems that when an Islamic bank lends someone money it's more of a business deal between partners rather than a debtor - debt collector type of relationship. This different way of functioning interested me so I deviated from the reading to investigate further. When people borrow money to buy a house banks profit by charging "rent" or a borrowed price that is higher than the market value of the house is initially agreed upon. This is profit acts as a reward to the bank for the risk that they assume.