y v reddy : monetary policy - an outline presidential address by dr y v reddy, governor of the reserve bank of india, circulated in the annual conference of andhra pradesh economic association, visakhapatnam, 12 february 2005. * * * respected vice - chancellor professor simhadri, professor bhanoji rao, professor k. c. reddy, and fellow - members of andhra pradesh economic association. i am thankful to the organisers for inviting me to be the president and deliver the presidential address. there are several reasons for my being keen to be in visakhapatnam to deliver the presidential address. i commenced my career in government of andhra pradesh in visakhapatnam as assistant collector under training over forty years ago - in 1965. i had the benefit of professional guidance from eminent scholars and economists in andhra university such as professors sarveswara rao garu, d. v. ramana garu, g. parthasarathy garu, k. v. ramana garu and s. chandrasekhar garu. subsequently, i acquired many friends with strong links here, such as professors krishnamurthy garu and r. radhakrishna garu. professor bhanoji rao garu has been a valued friend, whether he was in the world bank with me, or in singapore or in the administrative staff college in hyderabad. professor k. c. reddy garu worked alongside me when i was the secretary in planning and finance department of the government of andhra pradesh. with all these attractions, i regret to say that i am not able to be physically present in visakhapatnam to deliver the presidential address at the 23rd annual conference due to unavoidable official commitments. the andhra pradesh economic association has been one of the pioneering efforts in our country in organising a sub - national level professional body of economists. i have no doubt that it is a wise initiative and needs to be carried forward. as the economic reform in india progresses, the relative balance in public policy would shift in favour of the states relative to the centre. the important areas earmarked for the centre, such as external sector and financial sector, tend to be subjected to globalisation while in areas such as education, health, sanitation, roads, water works, power, etc. which are localized in nature, states could have a greater role. greater marketisation of economies and private capital flows tend to look for conducive governance at the state - level where economic activities

( a ) fixed exchange rate, ( b ) open capital account, and ( c ) independent monetary policy. the basic message of the ‘ trilemma ’ is that a central bank can achieve any two of the above - mentioned parameters, but not all the three. illustratively, if a country wants to have fixed exchange rate and independent monetary policy then it is difficult to maintain an open capital account. another important issue in monetary policy is the extent of transparency. central bankers all over the world are not exactly known for clarity in their language. nevertheless, the rational expectations school in macroeconomics holds that no policy can be successful over a period by “ fooling ” the economic agents. in this context, one may differentiate between genuine uncertainties about the future vis - a - vis not revealing the expected outcome of the policy. in fact, since the 1990s, there has been a preference all over the world to improve the transparency of monetary policy. in the context of improving transparency, the recent trend has been towards direct inflation targeting. adoption of explicit inflation targeting as the final goal of monetary policy involves the preparation of an inflation forecast, which, in a way, serves the purpose of both an intermediate target and final objective. the pre - requisites for inflation targeting include a considerable degree of operational autonomy or independence for central bank, flexible exchange rate conditions, well - developed financial markets and absence of fiscal dominance. in view of the growing complexities of macroeconomic management, several central banks including the european central bank have placed reliance on a broad set of economic and leading indicators rather than focusing exclusively on an intermediate target or a direct inflation target. the federal reserve has traditionally been following a more broad based approach to the conduct of monetary policy in the us. operating procedures : instruments and targets operating procedures refer to the day - to - day implementation of monetary policy by central banks through various instruments. these instruments can be broadly classified into direct and indirect instruments. typically, direct instruments include required cash and / or liquidity reserve ratios, directed credit and administered interest rates. cash reserve ratio ( crr ) determines the level of reserves ( central bank money or cash ) banks need to hold against their liabilities. similarly, liquidity reserve ratio requires banks to maintain a part of their liabilities in the form of liquid assets ( e. g., government securities ). credit and interest rate directives take the form of prescribed targets for allocation of credit to preferred sectors / industries and prescription of deposit and