between quarterly average overnight call rate and interest rate obtained from the taylor rule, and inflation gap as the difference between quarterly average inflation rate and target inflation ( chart 6 ). it showed statistically significant inverse correlation which implies that higher the deviation of policy rate from that implied by the simple taylor rule, higher is the deviation of inflation from its desired level. 9 correlation coefficient of – 0. 78 which was statistically significant at 1 per cent. bis central bankers ’ speeches chart 6 : interest rate gap mirrored inflation gap moreover, in the crisis period, the gap had widened which has since narrowed in 2012 – 13. additional diagnostics suggested bi - directional causality between the interest rate gap and inflation gap. it is noteworthy that this gap was narrower during the high growth phase of 2003 – 08. conclusion let me conclude. the taylor rule has been extensively used to understand the interest rate setting behaviour of central banks across the world. recent empirical work including the simple characterisation i have presented here suggests that a taylor - type rule could be a useful additional tool in understanding the interrelationship among growth, inflation and policy interest rate as the interest rate channel of monetary transmission strengthens. at the same time, it should be emphasised that taylor rule has its limitations as exclusive emphasis on interest rates with the neglect of other variables may not be optimal for an emerging market economy like india. in my presentation if i have raised more questions than provide answers, i would have succeeded in my intention. there is a need for further research to enhance our understanding of appropriate interest rate structure which is conducive to price stability in the medium - to long - term. thank you. bis central bankers ’ speeches

be the appropriate policy rate that would return the economy to its potential level without causing inflation. if these goals are in conflict in the sense that inflation is above its target and the economy is growing below its potential or vice versa, the rule provides guidance on how to balance these competing considerations in setting an appropriate level for the policy interest rate. while β and γ could be estimated from data, taylor assumed those as 0. 5 each. in a sense it assigns equal weights to both inflation and growth objectives. this is a reasonable assumption considering that most central banks are concerned both with inflation and growth. these dual objectives are built into many central bank statutes, including that of the us. he also additionally assumed that desired level of inflation for the us was 2 per cent per annum and the equilibrium real policy rate was 2 per cent per annum. taylor ( 1993 ) showed that a simple monetary policy rule, where the us fed raises the interest rate if inflation rate exceeds a 2 per cent implicit target or if real gdp growth is higher than its potential, describes quite well the actual path of the fed funds rate between 1987 and 1992. the linear framework of taylor rule is, however, criticized by many on the ground that central banks have asymmetric preferences for interest rate smoothing depending on the direction of their monetary policy stance. in addition to changes between discretionary and rule - based policy regimes, economic theory provides several reasons for deviating sometimes from a symmetric and linear policy rule framework ( gerlach, 2000 ) 4. an accepted way of representing such behaviour in literature is to assume that actual interest rate it gradually adjusts to the desired rate as : ιt = ρit - 1 + ( 1 - ρ ) ιt *, where captures the observed smoothing of the policy rate by the central bank, i. e., the smoothing parameter. substituting this in the original taylor rule formulation in ( 1 ), the modified taylor rule with smoothing takes the form as : it may be noted that equation ( 2 ) is not linear in parameters and hence parameters ρ, α, β and γ are estimated from the observed data by non - linear least square method. gerlach, s., ( 2000 ) : “ asymmetric policy reactions and inflation ”, working paper, bank for international settlements. bis central bankers ’ speeches estimates for india in india there has not been much research on monetary policy rules partly because the underlying monetary framework largely relied on direct and quantity based instruments. moreover, the commercial interest rate