prudential measures such as specifying exposure norms and pre - emptive tightening of risk weights and provisioning requirements. but these measures are not always costless. for instance, tightening of risk weights arguably tempers the flow of credit to certain sectors, but excessive, premature or unnecessary tightening could blunt growth. similarly, exposure norms offer protection against concentration risks ; however, such limits could restrict the availability of credit for important growth sectors. thus, as in the case of price stability, central banks face the challenge of managing the trade off between financial stability and growth. 34. it needs to be recognized that after a crisis, with the benefit of hindsight, all conservative policies appear safe. but is there a risk of throwing away the baby with the bathwater? excessive conservatism in order to be prepared to ride out a potential crisis could thwart growth and stifle innovation. the question is what price are we willing to pay, or put another way, what potential benefits are we willing to give up, in order to cope with a black swan event? experience shows that managing this challenge, that is balancing the costs and benefits of regulation, is more a question of good judgement rather than analytical skill. this judgement skill is the one that central banks, especially those of developing countries such as india, need to hone as they simultaneously pursue the objectives of growth and financial stability. fifth challenge : managing the balance between the autonomy and accountability of central banks 35. finally, let me turn to the fifth challenge, as i see, which is to do with managing the balance between the autonomy and accountability of central banks. this is a broad spectrum topic that draws from several issues that i have touched upon earlier. 36. the seventy odd years since the great depression saw a famous rivalry between fiscal and monetary policies for influence. historically central banks suffered from fiscal dominance since they had to acquiesce in governments “ borrowing as much as required at as low a cost as possible ”. this state of affairs started changing in the 1980s with a wave of support for central bank independence. the support was largely in response to the damage inflicted by the stagflation of the 1970s and the clear lesson that high inflation is detrimental to sustainable growth. so, fiscal dominance gradually yielded to independent central banks targetting largely, and in some cases exclusively, price stability, free of short term political imperatives. empirical work shows that in the two decades during which central bank independence gained ascendancy, there was

there was an extended period of price stability accompanied by stable growth and low unemployment. in the world that existed before the crisis, central bankers were a triumphant lot. they had discovered the holy grail. 13. the unravelling of the great moderation during the crisis has diluted, if not dissolved, the consensus around the minimalist formula of inflation targetting. the mainstream view before the crisis was that price stability and financial stability reinforce each other. the crisis has proved that wrong. we have seen that price stability does not necessarily ensure financial stability. indeed there is an even stronger assertion – that there is a trade - off between price stability and financial stability and that the more successful a central bank is with price stability, the more likely it is to imperil financial stability. 14. all in all, the crisis has given fresh impetus to the “ new environment hypothesis ” that pure inflation targetting is inadvisable and that the mandate of central banks should extend beyond just price stability. let me therefore turn to what the mandate should extend to. ( ii ) what is the role of central banks in preventing asset price bubbles? 15. a dominant issue in the wake of the crisis has been the role of central banks in preventing asset price bubbles. the monetary stance of studied indifference to asset price inflation stemmed from the famous greenspan orthodoxy which can be summarized as follows. first, asset price bubbles are hard to identify on a real time basis, and the fundamental factors that drive asset prices are not directly observable. a central bank should not therefore second guess the market. second, monetary policy is too blunt an instrument to counteract asset price booms. and third, central banks can “ clean up the mess ” after the bubble bursts. the surmise therefore was that the cost - benefit calculus of a more activist monetary stance of “ leaning against the wind ” was clearly negative. in other words, it is not the job of central bankers to remove the punch bowl no matter that the party is getting wild. 16. the crisis has dented the credibility of the greenspan orthodoxy. the emerging view post - crisis is that preventing an asset price build up should be within the remit of a central bank. opinion is divided, however, on whether central banks should prevent asset bubbles through monetary policy action or through regulatory action. on one side, there is a purist view that the case for monetary tightening to check speculative bubbles is questionable. opposed to this is the argument that a necessary