duvvuri subbarao : price stability, financial stability and sovereign debt sustainability policy challenges from the new trilemma inaugural speech by dr duvvuri subbarao, governor of the reserve bank of india, at the second international research conference of the reserve bank of india, mumbai, 1 february 2012. * * * i have great pleasure in welcoming you all to the reserve bank ’ s second international research conference ( sirc ). we held our first international conference two years ago, in february 2010, as a flagship event of our platinum jubilee celebrations. many of you who had attended that conference complimented us for its quality and urged us to repeat it. as much as we were flattered by those compliments, i also suspect that the urging for a repeat was at least partly motivated by the prospect of escaping from the bitter cold of some of your home countries at this time of the year. so, here ’ s welcoming all of you to warm and sunny mumbai. conference theme let me start by explaining the motivation for the conference theme : “ price stability, financial stability and sovereign debt sustainability : policy challenges from the new trilemma ”. the global financial crisis followed by the euro zone debt crisis has changed the theology of central banking in a fundamental way. the orthodoxy of central banking before the 2008 crisis was : single objective – price stability ; single instrument – short - term interest rate. although most central banks deviated to different extents from this minimalist model, this came increasingly to be considered the holy grail. the crisis came as a powerful rebuke to central banks for having neglected financial stability in their single - minded pursuit of price stability. by the time of our first conference two years ago, a consensus was developing around the view that financial stability has to be within the explicit policy calculus of central banks, although opinion was divided on the precise nature of institutional arrangements for maintaining financial stability. fast forward to 2011 / 12. even as central banks are grappling with balancing the demands of price stability and financial stability, there is now yet another powerful assault on central bank orthodoxy arising from the big elephant in the room – the euro zone sovereign debt crisis. the european central bank ( ecb ) is being called upon to bend and stretch its mandate to bail out sovereigns who have forfeited the confidence of markets. actually that is an understatement. in reality, the ecb is being challenged on why it is, to use an indian word, being

of the principal causes of the crisis was the unbridled bis central bankers ’ speeches autonomy of central banks. the standard argument for central bank autonomy is that autonomy enhances the credibility of the central bank ’ s inflation management credentials. monetary policy typically acts with a lag, and price stability therefore has to be viewed in a medium term perspective. having autonomy frees the central bank from the pressure of responding to short - term developments, deviating from its inflation target and thereby compromising its medium term inflation goals. now that the importance of central bank autonomy in monetary policy has come to be largely accepted, the question is : will additional responsibilities underlying the new trilemma affect that autonomy? and how will this new situation also affect the accountability structures of the central banks? it may be useful to take stock of the apprehensions in this regard. for overseeing systemic stability, new governance structures have emerged after the global crisis. these include the financial services oversight council ( fsoc ) in the us, the financial policy committee ( fpc ) in the uk and the european systemic risk board ( esrb ) in the eu. here in india, we have the financial stability and development council ( fsdc ). the precise institutional arrangements vary, but across all of them, central banks have a lead responsibility. with these new institutional arrangements for financial stability in place, the autonomy question has acquired an additional dimension. note that central bank autonomy has worked because they could keep at arms length from the governments. but once a coordination mechanism is in place, these barriers may melt away. also, even if that is what the book says, it may be difficult to straitjacket the discussion at the coordination forum to financial stability. as we have seen, there are no “ pure ” financial stability issues ; they are all interconnected. a discussion on financial stability could very well lead to a discussion on monetary policy. what then of the autonomy of the central bank? this apprehension, as all of you will appreciate, is non - trivial. if we now add responsibility for sovereign debt sustainability to this already complex situation, the reason for apprehension about the threat to the autonomy of central banks becomes more obvious. sovereign debt is a quintessentially political subject, and as we noted earlier, the very foundation of central bank autonomy is justified on the need to free monetary policy from fiscal dominance. by requiring central banks to be mindful of sovereign debt sustainability concerns as part of the “ new trilemma ”,