prudential measures such as specifying exposure norms and pre - emptive tightening of risk weights and provisioning requirements. but these measures are not always costless. for instance, tightening of risk weights arguably tempers the flow of credit to certain sectors, but excessive, premature or unnecessary tightening could blunt growth. similarly, exposure norms offer protection against concentration risks ; however, such limits could restrict the availability of credit for important growth sectors. thus, as in the case of price stability, central banks face the challenge of managing the trade off between financial stability and growth. 34. it needs to be recognized that after a crisis, with the benefit of hindsight, all conservative policies appear safe. but is there a risk of throwing away the baby with the bathwater? excessive conservatism in order to be prepared to ride out a potential crisis could thwart growth and stifle innovation. the question is what price are we willing to pay, or put another way, what potential benefits are we willing to give up, in order to cope with a black swan event? experience shows that managing this challenge, that is balancing the costs and benefits of regulation, is more a question of good judgement rather than analytical skill. this judgement skill is the one that central banks, especially those of developing countries such as india, need to hone as they simultaneously pursue the objectives of growth and financial stability. fifth challenge : managing the balance between the autonomy and accountability of central banks 35. finally, let me turn to the fifth challenge, as i see, which is to do with managing the balance between the autonomy and accountability of central banks. this is a broad spectrum topic that draws from several issues that i have touched upon earlier. 36. the seventy odd years since the great depression saw a famous rivalry between fiscal and monetary policies for influence. historically central banks suffered from fiscal dominance since they had to acquiesce in governments “ borrowing as much as required at as low a cost as possible ”. this state of affairs started changing in the 1980s with a wave of support for central bank independence. the support was largely in response to the damage inflicted by the stagflation of the 1970s and the clear lesson that high inflation is detrimental to sustainable growth. so, fiscal dominance gradually yielded to independent central banks targetting largely, and in some cases exclusively, price stability, free of short term political imperatives. empirical work shows that in the two decades during which central bank independence gained ascendancy, there was

rakesh mohan : recent financial market developments and implications for monetary policy valedictory address by dr rakesh mohan, deputy governor of the reserve bank of india, at the institute of international finance ’ s inaugural asia regional economic forum, mumbai, 20 september 2007. assistance of m. d. patra and indranil bhattacharya in preparing the speech is gratefully acknowledged. * * * shri bhatt, mr horiguchi, ladies and gentlemen, i am honoured to be invited to deliver the valedictory address at the asia regional economic forum. the relationship between india and the institute of international finance ( iif ) goes back a long way to the early 1990s. therefore, it is only befitting that the iif has chosen to inaugurate the asia regional economic forum in mumbai as an opportunity for the informal exchange of ideas and views on the region and the global economy, with emphasis on key issues relating to india. i observe from the proceedings of the forum that there has been a timely focus on and comprehensive coverage of developments in global and regional financial and commodity markets, the financial system at large and issues relevant for emerging asia. over the last two months, a good deal of our collective attention has been focused on the turmoil in financial markets in the united states and europe and the sudden plunge in credit market confidence triggered by emerging risks to exposures to the us sub - prime mortgage crisis. even as every passing day unravels a little more of the underlying forces at work – the complex nature of the derivatives used ; the high degree of leveraging on poor, light or even absent collateral ; the underestimation of risk pervading financial markets ; the surprisingly sizeable exposures of large financial institutions to some of the debt instruments and derivatives in question ; and the speed of contagion – i believe that we still have to travel much further before we understand the full import of these recent events in terms of both information and analysis. consequently, there is considerable uncertainty surrounding both debt and credit markets as of now. quite justifiably, regulators, monetary authorities and finance ministries are all engaged in containing the risks posed by these developments. in my address, i thought i would take this opportunity to stand back from the actual play of events and try to gain an understanding of the nature of the turbulence, why it happened, where it happened, and the implications for central banks. in the rest of my address, i will reflect on some over