rakesh mohan : risk management in an open market economy speech by dr rakesh mohan, deputy governor of the reserve bank of india, at the inaugural programme of the centre for advanced financial learning, mumbai, 4 june 2007. assistance of k. damodaran and himadri bhattacharya in preparing the speech is gratefully acknowledged. * * * peter l. bernstein in his celebrated book against the gods writes, “ the revolutionary idea that defines the boundary between modern times and the past is the mastery of risk : the notion that the future is more than a whim of the gods and that men and women are not passive before nature. until human beings discovered a way across that boundary, the future was a mirror of the past or the murky domain of oracles and soothsayers who held monopoly over knowledge of anticipated events ” ( bernstein, 1996 ). whereas risk management characterizes many of our activities in different spheres, from standard technological risk management embedded in almost all industrial goods and machinery, to worrying about climate change and global warming, it is in the world of finance that risk management is at the core of all its activities. with the generalized opening of trade and of capital movement across the world over the past decade and a half, risk management has become all pervasive across the whole financial sector. in a closed economy with administered prices, fixed or predictable exchange rates and interest rates, the micro perception of risk was relatively benign. in those conditions, in effect, it was the sovereign that undertook to do the risk management for the economy. as a consequence of the rigidity embedded in these systems, economic adjustments did not take place on a day - to - day gradual basis and risks effectively accumulated until discontinuous macroeconomic adjustments were forced on the system. such discontinuous adjustments involved non - marginal adjustments in the exchange rate, interest rates, administered prices of basic goods, or in fiscal expenditures, and the like. the impact on individuals and market participants alike was usually relatively traumatic, and consequent economic and financial crises were common. moreover, such systems were likely to suffer from misallocation of resources, bouts of price instability and consequential low and uncertain economic growth. the notion that individual economic agents are ill - equipped to be exposed to exchange rate, interest rate and price risks, and that the sovereign alone should bear these risks is no longer regarded as tenable. it is now recognized that a system that allows for daily market

- job flows remain around post - crisis highs and the ratio of vacancies to unemployment is now back to its pre - crisis average. however, what matters for inflation is not wage growth in isolation but wage growth relative to productivity. put simply, firms are less likely to raise their prices if higher wages reflect more output per hour worked. along with faster wage growth, there have been signs of faster productivity growth since the turn of the year. this may well mean firms ’ unit labour costs have not picked up quite to the degree we had expected in our may inflation report. it ’ s too early to be definitive. weighing past disappointments and recent indications of a pick - up, it is prudent to recognise that two - sided risks to productivity growth remain. what is clear is that to return inflation to target, growth in labour costs must pick up further from their current rate of less than one per cent. the extent needed depends on what is happening to other costs. in the decade prior to the crisis, labour costs grew by around 2½ per cent each year on average, with wages and salaries growing at around 4¾ per cent and productivity at 2¼ per cent. inflation averaged 2 per cent, 27 however, in part because import prices rose only by around ¼ per cent each year at the same time. the possibility that history might repeat itself points to a third important consideration : the need to monitor developments in firms ’ costs other than labour. the sum of these is evident in so - called “ core ” inflation, which are measures of prices that strip out the most volatile determinants of inflation, like energy prices, revealing more persistent trends. in an open economy like the united kingdom ’ s, those factors include import prices, which are affected by movements in the value of sterling, and which, on past experience, can take a considerable time to pass through to core inflation. 28 in our may projections, the mpc expected ppp - weighted worth growth of 3 ¼ per cent in 2015 and 3 ¾ per cent in 2016 and 2017, just shy of the pre - crisis average of around 4 per cent. i discussed labour supply developments in the uk in detail last autumn. see carney, m ( 2014 ), speech to the trades union congress annual conference, 9th september 2014. unlike regular pay, bonuses are closer in spirit to dividend payments, being state - contingent disbursements of profits. that observation may imply bonus payments are a useful cyclical indicator,