The behavior of the Taylor rule in the presence of sovereign Sukuks based on the growth rate of the economy: An analysis by DSGE modelling

Abstract

The aim of this paper is to study the behavior of the Taylor rule in the presence of Sukuks. The New Keynesian model of Gali (2008)/Chapter 3 is used, due to its simplicity and small size. Nevertheless, such a model is suitable for examining the implications of monetary policy in the presence of sovereign Sukuks. The growth rate is used as the rate of return on sovereign Sukuks, which is closest to the profit and loss sharing approach, and is compared to the Gali’s baseline model. The results show that the introduction of sovereign Sukuks mitigates inflation and output gap shocks, but also limits the scope of the Taylor rule. Thus, an increase in the interest rate is offset by a flight of capital from sovereign Sukuks to treasury bonds, while a decrease in the interest rate leads to a flight from treasury bonds to sovereign Sukuks. In the extreme, if the preference for Sukuks is largely dominant, the Taylor rule tends to be obsolete, and vice versa.