avoid this, monetary policy has to be tightened to curb domestic demand, so that weaker demand gradually offsets the inflationary effects of the supply side shock. this is why we tightened monetary policy in 2011, by raising interest rates. as you may remember, the central bank rate ( cbr ) was raised very sharply in the second half of 2011 because the supply side shock to prices was itself very large ; for example, annual food price inflation rose to 50 percent in september 2011. once we saw evidence that inflationary pressures were abating and we were convinced that inflation was on a downward path, we were able to begin cautiously easing monetary policy, by reducing the cbr in february of this year. inflation has now been brought back down to our medium term target of 5 percent. looking ahead over the next 12 months, we intend to set our monetary policy, using the cbr, to maintain core inflation as close as possible to 5 percent. although inflation is the primary target of our monetary policy, we are also concerned with the growth of real output, which is a secondary objective of monetary policy. more specifically we aim to ensure that real output is in line with its potential level, which is determined by supply side growth. this means that, in circumstances where real output is below its potential bis central bankers ’ speeches level, we will use monetary policy to support a recovery of output provided that this does not undermine our ability to achieve our inflation target. in some circumstances, notably when the economy has suffered an aggregate supply shock, as was the case in 2011, there is an unavoidable conflict between achieving both the inflation and output targets. in these circumstances the inflation target has to take precedence, because otherwise the credibility of the central bank to control inflation will be jeopardized. however there are other circumstances where there is not an inherent conflict between the inflation and output targets. with the supply side shocks which hit our economy in 2011 having now abated, the conflict between the inflation and output targets has also largely dissipated, although it could re - emerge if the economy were hit by further supply side shocks in the near future. we estimate that the potential growth of real output of our economy – which is determined by the growth of the labour force, capital investment and productivity growth – is currently in the region of 6 – 7 percent per annum. in the last fiscal year, real output growth was only 3. 4 percent ; about half of the potential growth rate. as a consequence, a negative

monetary policy plays a very important role in guiding expectations about the economy and the actions of the central bank. that is why we announce the cbr publicly at the start of every month and explain the thinking behind our interest rate decision. since the itl framework was introduced, we have been able, using our regular interventions in the money market, gradually to bring short term interbank interest rates quite closely into line with the cbr. the average 7 day interbank rate for november was 12. 6 percent, which is very close to this month ’ s cbr of 12. 5 percent. in turn other interest rates such as those paid on wholesale deposits are now also moving roughly in line with the cbr. as such the bis central bankers ’ speeches cbr is now proving quite effective in influencing the marginal cost of funds for commercial banks. we have been less successful in influencing the path of bank lending rates ; they followed the cbr up in the second half of 2011 but have been much slower in coming down this year, with the result that interest rate spreads have widened. i hope that, as our financial sector becomes more competitive and sophisticated, we will see bank lending rates become more responsive to changes in the marginal cost of funds for banks and interest rate spreads being reduced. finally i will briefly touch on the instruments of monetary policy. in the past, the main instrument of monetary policy was the regular primary auction of government securities, which we used as a tool to control the monetary base. under the itl monetary policy framework, our operating target is the interbank interest rate, not the monetary base, and the tool we use to influence the interest rate is secondary market operations in the money market, mainly repos and reverse repos. the primary auctions of government securities are now used to fund the government ’ s domestic borrowing requirement and to refinance the existing stock of securities as they mature, rather than as an instrument of monetary policy. furthermore, the government will fund fully its domestic borrowing requirement from the market, by issuing securities, without recourse to any funding from the central bank. it is possible that we might occasionally use a primary auction of securities for monetary policy purposes in the future, but this will be the exception rather than the rule and if we do so we will announce this explicitly, to avoid any confusion. i hope that you have found these remarks useful. as i noted earlier, transparency and communication play a vital role in modern monetary policy frameworks, so it is