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This paper argues that there is scope for monetary policy under an exchange rate anchor, and discusses the related monetary policy design and implementation. It shows that the exchange rate can be used as the main monetary policy instrument while the policy rate can target the exchange rate. An exchange rate anchor is compatible with an inflation objective, provided fiscal dominance is not an issue, monetary conditions are supportive of the peg, and the level of international reserves is adequate. The paper argues that, while an exchange rate anchor is more prone to policy inconsistencies, there is ample scope for strengthening monetary policy design and implementation under soft pegs. In that context, the principles of dichotomy and interest rate parity are critical.

This paper discusses key issues related to the conduct of monetary policy in countries that have Islamic banks. It describes the macrofinancial background and monetary policy frameworks where Islamic banks typically operate, and discusses the monetary transmission mechanism in economies where Islamic and conventional banking coexist. Most economies with Islamic banks also have conventional banks and this calls for a comprehensive approach to monetary policy. At the same time, a dual approach to monetary policy should be considered whenever the Islamic segment of the financial system is not as developed as the conventional one. The paper tries to shed light on potential spillovers between conventional and Islamic financial systems, and proposes specific recommendations on the design of Islamic monetary policy operations and for facilitating monetary transmission through the Islamic financial system.

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