The basic objective of the Islamic code of life is human welfare which, at the national level, the government has been made responsible to supervise and help realize through deliberate policies and efforts. In the economic field, the government is to guarantee basic needs of all the citizens, help and supervise full employment of all the resources, ensure implementation of Islamic norms and values in factor pricing and transfer payments which lead to an equitable distribution of income and wealth, and thus play a positive and important role in economic development of the Islamic economy.

All these involve appropriate economic policies on the part of the government. The two major and broad categories of policy measures at its disposal are the monetary and fiscal policies. Monetary policy refers to the control of the supply of money, its availability, its pricing, and the direction of its use by applying appropriate monetary tools in order to achieve certain policy objectives. On the other hand, fiscal policy refers to the manipulation of the relevant sources of government revenues including taxes and the direction and size of government expenditure by using fiscal tools in order to materialize policy goals of the economy. This paper deals with the objectives and instruments of monetary and fiscal policies and their implications for economic development.

The basic assumptions of the model underlying the paper are as follows. First, the government is committed to establish Islam at all levels and, accordingly it plays its positive and Hisba (supervisory) roles in the economy including the collection and disbursement of zakat. Second, interest is abolished from the financial system, and the banking transactions are mainly equity-based. Third, the economy consists of three sectors, namely, the consumers, the producers and the government. For example, the producers may be of several kinds, including Mudaraba participants (sleeping partners contributing investible surplus) and Musharaka participants (active participants with both capital and entrepreneurship). Fourth, the economic agents follow the Islamic ethics of economic behavior.

Core Concepts: Human Welfare, Hisba Role, Zakat, Interest-free Finance, Mudaraba & Musharaka, Equity-based Banking, Monetary & Fiscal Tools, AUB.