Enhancing Cyclical Stability by Interest-Free Banking

Cyclical instability in the form of business cycles has been a bane of modern economies for decades. A major cause of business cycles is the introduction and utilisation of debt financing. Remedies based on the Keynesian paradigm provide only temporary stopgap measures that, while alleviating conditions in the short term only make the problem of instability worse in the long run. The main reason is that Keynes’ analysis fails to trace cyclical instability to its real cause, which is financing spending - private as well as public – by borrowing. Accordingly, this paper argues that achieving cyclical stability requires replacing ‘financing by borrowing at interest’ with ‘financing on the basis of risk sharing.’ This can be expected not only to reduce not only cyclical instability, but to bring other benefits as well.