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Zafar Iqbal and Mervyn K. Lewis

generation and having a finite life which overlaps with the successive generation – optimizing inter-temporal consumption over their life cycles through borrowing and lending in perfect capital markets. In such a setting, bond-financed budget deficits shift taxes to future generations, reduce savings, raise interest rates1 and lower the stock of capital, thereby decreasing welfare in the long run. This result was first derived by Diamond (1965) based on lump sum taxes but reinforced by Auerbach and Kotlikoff (1987) who use a 55-period life-cycle simulation model to show

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Zafar Iqbal and Mervyn K. Lewis

Usury or interest has attracted the close scrutiny of religious scholars and philosophers for centuries. The oldest scriptures of Hinduism, based on the Veda, condemned interest lending as a major sin (Rangaswami, 1927; Gopal, 1935). Plato and Aristotle opposed interest on the grounds that it contravened natural law and retarded the development of higher 214 Financing methods for government bodies 215 moral values. Judaism and Christianity banned interest (usury). Hebrew law prohibited it, at least among Jews (‘brethren’). Christianity was even more unequivocal on

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Zafar Iqbal and Mervyn K. Lewis

them to invest. Given no fixed-interest outlet, investment in any project (irrespective of location) having net positive expected rate of return thus becomes feasible. Note also that the levy on wealth (zakah) if properly charged, could, in addition to the above role, address the problem of low consumption. Conclusion 323 The conventional economic concern on this solution would be that the savings ratio will drop owing to zakah. Again, such is the confidence of Islam on the ‘natural’ propensity of people to save that, on balance, there is no excessive worry about

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Zafar Iqbal and Mervyn K. Lewis

ways: by printing money, and by borrowing. However, a moment’s reflection is sufficient to appreciate that these are not really alternatives at all. If money is printed faster than it is demanded, then it will generate inflation and inflation is simply a different form of tax – essentially a tax on money balances (Friedman, 1963).2 If, on the other hand, cash is created in line with demand, then it represents borrowing by means of government debt, but in this case at a zero rate of interest via seigniorage. Moreover, if we accept the argument of Buchanan (1958