##s to calibrate the flows ; in essence they define the boundaries of the playing field. tactical controls, on the other hand, introduce barriers into the playing field itself. they are deployed opportunistically to stem a surge in inflows or outflows. by their very nature, tactical controls introduce a new element of uncertainty into the calculations of both domestic and foreign stakeholders. india ’ s approach to capital account management is typically strategic. for example, we have an explicitly expressed preference for long term over short term flows and equity over debt flows, and we have used both price based and quantity based controls to operationalize this policy. we have, of course, periodically recalibrated elements of the strategy in pursuit of capital account liberalization. an important lesson from india ’ s experience is that even with relatively large swings in capital flows during the crisis, the pressure to use tactical controls did not build up because the strategic controls provided automatic buffers. even as we debate what emes should or should not do to manage excess capital flows, we should remember that to the extent that lumpy and volatile flows are a spillover from policy choices of advanced economies, managing capital flows should not be treated as an exclusive problem of emerging market economies. how this burden is to be shared raises both intellectual and practical challenges. the intellectual challenge is to build a better understanding of the forces driving capital flows, what type of policy instruments, including capital controls, work and in what situations. the practical challenge is the need to reach a shared understanding on a framework for cross border spillovers of domestic policies in capital - originating countries, and the gamut of policy responses by capital receiving countries. lesson 7 : economics is not physics a few months into the crisis, the queen happened to be at the london school of economics and asked a perfectly sensible question : “ how come none of the economists saw the crisis coming ”. the queen ’ s question resonated with people around the world who felt that they had been let down by economics and economists. as economists saw their profession discredited and their reputations dented, the economic crisis soon turned into a crisis in economics. what went wrong with economics? it now seems that by far the most egregious fault of economics, one that led it astray, has been to project it like an exact science. the charge is that economists suffered from “ physics envy ” which led them to formulate elegant theories and models – using sophisticated mathematics with

and then keep it there. we have based our monetary policy on this framework not because we only care about inflation, but because we think it will give us the best result for the whole economy in the long run. in particular, if applied sensibly, it will enable the economy ’ s average growth rate to reflect its potential growth rate and therefore deliver the maximum sustainable increase in employment and living standards. we have already seen nine years of expansion with growth averaging over 4 %, a considerably longer expansion than we were able to achieve in the 1970s and 1980s. and there is every prospect that the expansion will continue for a good deal longer. for the first time in my working life, australia in the 1990s has come near the top of the decade growth rates among developed countries. we grew faster than the united states, and only ireland, among developed countries, recorded faster growth. this growth occurred at a time when our inflation rate averaged about 2¼ %, a good deal lower than in earlier decades, and comparable with international standards. there was also less variability from year to year in growth than in earlier expansions, although some variability is inevitable : we have had annual growth rates at over 5 % and at less than 3 % during this expansion, yet its fundamental momentum has remained intact. i think the system has proved itself to be a very good one, and i am confident that it is the best way to ensure that monetary policy makes sense in the medium term. it is also worth noting that during the course of the expansion, we have had one complete cycle in interest rates - rises in 1994, then falls in 1996 - 98. these played their part in sustaining the expansion. the increase in official interest rates of 125 basis points that has occurred over the past seven months has to be seen in this context. for the present expansion to continue as long as possible, monetary policy has to be adjusted as circumstances change. the economy has been undergoing a shift from a period when inflation had been below the target to one where it was going to be in the target range. without policy adjustment, there was the prospect that it would, in time, rise above the desired range. until relatively recently, we were receiving information on economic activity that indicated the economy could even have been accelerating beyond the 4½ % growth that had prevailed over the 1997 to 1999 period. from our perspective, the decisions to raise interest rates were relatively straightforward. the situation is not as straightforward now. signs of a near - term acceleration in