modeling exercises in addressing a gathering of elite econometricians assembled here, a mention should be made about developments in monetary modeling. it is well recognized that monetary policy decisions must be based on some idea of how decisions will affect the real world and this implies conduct of policy within the framework of a model. as dr. william white of bank for international settlements ( bis ) mentioned in an address recently in rbi, “ the model may be as simple as one unspecified equation kept in the head of the central bank governor, but one must begin somewhere. economics may not be a science, but it should at least be conducted according to scientific principles recognizing cause and effect ”. while reliance on explicit modeling was rather heavy in some central banks, particularly in the 1960 and 1970s, there has been increasing awareness among the policy markers of the limitations of such models for several reasons. it is difficult to arrive at a proper model for any economy with the degree of certainty that policy makers want especially in view of observed alterations in the private sector behaviour in response to official behaviour. further, data to monitor the economy are sometimes inadequate, or delayed, and often revised. it is said that in regard to modern economies, not only the future but even the past is uncertain, due to significant revisions in data. the process of deregulation coupled with technological progress has led to increasing role for market prices and consequently more complexities for establishing relationships in an environment where everything happens very fast, and in a globally interrelated financial world. in brief, there is need to recognize the complexities in model building for monetary policies and approach it with great humility and a dose of skepticism but ample justification for such modeling work certainly persists. it is felt that this is an appropriate time to explore more formally the relationship among different segments of the markets and sectors of the economy, which will help in understanding the transmission mechanism of the monetary policy in india. with this objective in mind, rbi had already announced its intention to build an operational model, which will help the policy decision process. an advisory group with eminent academicians like professors mihir rakshit, dilip nachane, manohar rao, vikas chitre and indira rajaraman as external experts and a team from within the rbi were set up for developing such a model. the model was initially conceived to focus on the short term objective of different sources and components of the reserve money based on the recommendations of an internal technical group on liquidity analysis and forecasting

is a greater activism of central banks in liquidity management. • fourth, the greater activism through indirect instruments led to a more intensive use of open market operations ( omo ) through flexible instruments like repo. the omo can be used for net injection or absorption of liquidity and can be resorted to irrespective of whether the operating target works through the rate channel or quantity channel. • fifth, the market environment has induced many central banks to focus more on the interest rates rather than bank reserves in trying to influence liquidity. • sixth, increasing evidence of market integration implies that central banks can concentrate on the very short end of the yield curve. there is growing evidence in favour of comovements of interest rates of different maturity. this has simultaneously increased monetary policy challenges, as central banks have to keep a watchful eye on all markets and be cautious of any cascading effect or contagion emerging in the domestic economy or originating in a foreign economy. • seventh, at an operational level, while there is increasing transparency on the long - run strategic objective, central banks may not disclose their tactical considerations as some maneuverability in influencing the market is required. however, in many cases information is revealed to the market with a lag. many central banks also attempt to estimate market expectations directly through surveys. while market expectations play a major guidepost in formulating monetary strategies, information management plays a crucial role for short - run stabilisation. • eighth, a notable consequence of recent financial and currency crises has been the increasing emphasis on the quantity and quality of data dissemination, i. e., adequate, timely and reliable information in a standardized form. • ninth, a number of central banks now also disseminate the minutes of the meetings of major monetary policy decisions, which help to gain credibility and in building a reputation of the central bank in achieving the objectives of monetary policy. • tenth, an important issue is policy coordination between the fiscal and the monetary authorities. the stance of fiscal policy is important as it has a much broader spectrum of objectives. if fiscal authorities are the dominant players, monetary policy instruments are rendered less effective. as monetary policy evolves from a transitional setting of fiscal dominance, issues like direct access of government to central bank credit becomes important and crucial for fiscal - monetary coordination. • eleventh, policy coordination is also an important issue facing economies linked by trade and capital flows. in an increasingly synchronised business cycle environment, international policy coordination becomes extremely important