good, which includes the wage bill, cost of raw - material, acquiring and installing machines, and all other expenses. to remain in the business and earn profits, the producer would like to sell it at rs10 plus “ x ”. the rs “ x ” is generally termed as a mark up and depends on the degree of competition in the industry, nature of the product, overall administrative efficiency of producers and government authorities, adequate supply - chain infrastructure etc. what is over - looked in this simplistic example is the role of productivity of the factors of production, be it workers or machines. if the productivity is low and declining, then the final price tends to be higher even if the cost of acquiring the factors of production remains the same. put differently, the price can be kept stable or even reduced by increasing the productivity of workers and better and efficient use of technology. the monetary policy stance geared towards containment of overall inflation and thus stability of prices eases the pressures on the cost of production but cannot increase the productivity. factors positively influencing productivity include stable law and order conditions, a healthy and skilled labor force, effective governance, and uninterrupted availability of energy. a micro - level understanding of the price determination process is helpful, but a discussion on the behavior of prices or inflation at the aggregate level is also important. three broad parameters are worth mentioning in this regard : i ) - expectations about the continuation of inflationary trends ; ii ) - the output gap or the difference between aggregate domestic demand and the ability and capacity of the economy to meet that demand ; and, iii ) - cost push or supply shocks. expectations of likely inflation path have strong feedback effects on actual inflation. such expectations could be based on past inflationary trends or may be formed by the expected impact of government policies, or lack thereof, on inflation. for example, if an economy experiences high and rising inflation for some time then people tend to expect that this trend would continue and seek higher wages to at least maintain their purchasing power. typically, adjustment in wages tends to be slower than increases in the prices of goods and services that people consume. this leads to discontent and pressure on government authorities to control inflation and keep it stable. thus, managing the expectations of inflation by devising and implementing consistent and predictable economic policies is a critical task which is normally performed by central banks around the globe. however, the supporting role of other policies, such as fiscal policy, in assuring the public that the government is pursuing

##ities in 2005, for instance, the progressive hikes in the rate of interest in the united states at a time when monetary policy in europe was characterised by a waiting - game approach. despite these potentially destabilising factors, financial markets remained relatively calm. in currency markets, the dollar picked up in the wake of tighter us monetary policy, while the yen moved only slightly against the swiss franc. the exchange rate of the euro against the swiss franc fluctuated within a narrow range, thereby reflecting the strong convergence of fundamentals in switzerland and the euro area. over the past few months, the swiss franc has even trended downward – a decline that is hard to explain given the low rate of swiss inflation as compared to the rest of europe. if this trend were to accelerate and give rise to an excessive relaxation in monetary conditions with respect to economic developments, a normalisation of interest rates would become even more essential. generally speaking, the capacity of financial markets to absorb shocks and to cope with imbalances is one result of globalisation and the progress in financial intermediation. in addition to stimulating goods markets, globalisation has also enlarged and deepened financial markets, and is doing so to a growing extent. freedom of movement of capital is now the rule between industrialised countries and is also becoming more widespread in emerging countries. this makes it easier for the deficits of one group of countries to be financed by the surpluses of the others. in itself, the greater efficiency of financial markets is an additional factor contributing to growth, and is therefore a good thing. however, it is still possible that the continued indebtedness of some countries ( due to the substantial disparity in national savings efforts ) could dangerously weaken financial markets in the event of a crisis of confidence. the stability of global financial markets last year was a positive factor for our country, with its manifold connections to the global economy and a currency that has often suffered from external monetary turbulence. however, this high level of market stability should not be regarded as permanent. there are still major underlying risks and there is no justification for diminishing our vigilance as regards possible market instability. meanwhile, companies need to remain cautious about exchange rate risks, despite the fact that the volatility of the swiss franc has been low over the past few years. for its part, the snb is aware of the vulnerability of financial markets and takes particular care to ensure that its monetary policy is properly understood by economic agents