Rupee should stabilise once U.S. reduces speed of its rate increases: Economics Nobel winner

Douglas W. Diamond, the winner of the 2022 Nobel Prize in economics.
| Photo Credit: PTI

Douglas W. Diamond, winner of this year’s Nobel Memorial Prize in Economic Sciences, says it is difficult to predict exchange rates but the rupee should stabilise once the U.S. “reduces the speed of its rate increases”.

In an email interview to PTI, the American economist also said that when the U.S. raises exchange rates unexpectedly, the dollar tends to appreciate and things will normalise when interest rates are closer to each other in the U.S. and India.

Mr. Diamond, a Merton H Miller Distinguished Service Professor of Finance at the University of Chicago’s Booth School of Business, shared the Nobel Prize with former U.S. Federal Reserve Chair Ben Bernanke and U.S.-based economist Philip H. Dybvig for their research into the fallout from bank failures.

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According to the Nobel panel at the Royal Swedish Academy of Sciences in Stockholm, their research has shown “why avoiding bank collapses is vital”.

Asked about the continuous fall of the Indian rupee against the U.S. dollar, Mr. Diamond says, “It is difficult to predict the exchange rates. When the U.S. raises rates unexpectedly, the dollar tends to appreciate. Once the U.S. reduces the speed of its rate increases, the rupee should stabilise.” On Friday, the rupee appreciated 16 paise to 81.54 against the U.S. dollar.

Mr. Diamond, who had once observed that delegated monitoring allows savers to get access to safe and high returns, says bank monitoring works well when banks are well capitalised and there is little lending to bank insiders.

“I expect this to continue in the future. For savers to get high returns, a reasonable amount of bank competition is needed as well,” he argues.

Mr. Diamond, who had collaborated with former RBI Governor Raghuram G. Rajan on theory of banking in 2001, says one of their conclusions was that banks need to be a bit fragile to discipline them.

“This remains true. Short-term debt provides discipline because banks must continue to appear healthy to retain their funding. This possible loss of funding does make them fragile,” he says.

The research paper of Mr. Diamond and Mr. Rajan on ‘Liquidity Risk, Liquidity Creation, and Financial Fragility: A Theory of Banking’ was published in the Journal of Political Economy.

Mr. Diamond is known for his research in financial intermediaries, financial crises and liquidity. His research agenda for the past 40 years has been to explain what banks do, why they do it and the consequences of these arrangements. His selection for the Nobel was basically for his research towards enhancing the understanding of the role of banks in the economy, particularly during financial crises.

He says he was sound asleep at 3:40 a.m. when he got the news of his win early October.

According to Mr. Diamond, he was not expecting a Nobel though he had “heard that I was a possible contender 15 years ago, but in any given year it seemed very unlikely”.

The Nobel prizes, carrying a cash award of 10 million Swedish kronor (approx $9,00,000), will be presented in Stockholm and Oslo on December 10.