disturbing. indeed, once the immediacy of the crisis is behind us, it will not be surprising if we head for another round of destabilizing global imbalances. how do we manage global imbalances? it is argued that if the us fed had refused to supply the incipient demand for liquidity in the late 1990s and early 2000s, higher interest rates could have prevented the borrowing boom and the follow on widespread deterioration of financial standards and the subsequent melt down. but this also would have meant lower growth in the us and the rest of the world. the short point is that even as macroeconomic imbalances should not be allowed to proliferate, it is necessary to balance the need for global economic growth against the disruptions which follow the unwinding of such imbalances. resolving the problem of global imbalances does not mean eliminating them. as long as there is world trade, certain countries will have surpluses and certain others will run deficits. global imbalances have been, are, and will continue to be inevitable. so, to ask how we can eliminate global imbalances is clearly the wrong question. the right question is this : given that global imbalances are inevitable, how do we ensure that they do not build up to destabilizing levels? monetary & fiscal policy the second issue on questioning the questions relates to monetary and fiscal policy. unnerved by the scale and sweep of the crisis, governments and central banks around the world responded with an unprecedented show of policy force. the size and pace of monetary and fiscal expansion raised a paradoxical situation – even as governments and central banks coordinated and cooperated, many of their familiar conflicts got played out once again. central banks reduced policy rates ferociously, and in many advanced countries the rates are at or near zero. this is the standard tool of monetary policy whereby central banks expect to influence interest rates at the long end, and steer financial conditions and hence the entire economy by adjusting the short term rates. even in normal times, monetary policy transmission is lagged. in the crisis situation, because of the fear and uncertainty in the financial markets, it almost totally lost traction. central banks responded to this alarming impasse through a slew of measures variously described as quantitative and credit easing. it soon became clear that even as monetary policy became the first line of defence and central banks turned lenders of first resort, credit markets were in no mood to revive soon. so

the contrary, there will need to be increasing coordination between monetary and fiscal policies. central banks will have to take into account fiscal compulsions in their monetary stance while governments will need to commit to strict fiscal responsibility. to ask therefore how monetary and fiscal policies can go their separate ways is the wrong question. what is the right question? i submit the right question is : how can we coordinate fiscal and monetary policies to achieve the planned outcomes? inflation targetting i will now move to the third issue – inflation targetting. in the years leading to the crisis, central bankers had nearly declared victory. they had found the holy grail of stable growth, low inflation and low unemployment through a rule based monetary policy that targeted inflation rather than monetary aggregates. the much celebrated great moderation had delivered. the crisis at once hurt the central bankers ’ pride and shattered their confidence as the great moderation unravelled. monetary policy was found wanting in delivering financial stability. the undoing was the reluctance or failure of central banks to acknowledge increasing asset prices. the monetary stance of studied indifference to asset price inflation stemmed from the now notoriously 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. second, monetary policy is too blunt an instrument to counteract asset price booms. and third, a central bank cannot presume to know more than the market. the surmise therefore was that the cost - benefit calculus of a more activist monetary stance of “ leaning against the wind ” was clearly negative. it is more cost effective for monetary policy to wait for the bubble to burst and clean up afterwards rather than prick the bubble in advance. the great unravelling has, however, shattered the intellectual consensus around both inflation targeting and the greenspan orthodoxy on asset price build up. the crisis has made two things clear. first, the policy of benign neglect of asset price build up has failed. second, price stability does not necessarily deliver financial stability. where do we in india stand on inflation targetting? over the last few years, there has been an animated debate in india on inflation targeting fuelled by two influential studies, one by percy mistry and the other by raghuram rajan. while mistry strongly urged that the gold standard for stabilizing monetary policy is a transparent, independent, inflation - targetting central bank, rajan held that reorienting