'It's a tough time to be a central banker'

Nobel Laureate Douglas W. Diamond holds forth on managing inflation, setting monetary policy, the current global economic situation and how it will affect India

Douglas W. Diamond, often called the founder of modern banking theory, won the Nobel Memorial Prize in Economic Sciences in 2022 for path-breaking research aimed at enhancing the understanding of the role of banks in the economy, especially during financial crises. The 69-year-old Merton H. Miller Distinguished Service Professor of Finance at the University of Chicago,s Booth School of Business shared the prize with economists Ben Bernanke of the Brookings Institution and Philip Dybvig of Washington University in St. Louis. Over a video call with Business Today,s Anand Adhikari, Diamond shares his views on the developing economic situation around the world and its implications for India. Edited excerpts:

Q: What is the long-term impact of higher inflation, higher interest rates, and the strengthening of the dollar in emerging markets, particularly India? A: I have always thought about long periods of low interest rates in the US and other countries—as well as quantitative easing—as potentially excessive injections of liquidity, leading to expectations among financial institutions and firms that interest rates might stay close to zero forever. I thought there were some financial stability issues with that, as there was too much reliance on short-term debt. That’s the backdrop. I think that maybe they went too far in both Europe and the US by keeping interest rates where they were, and not thinking ahead enough about building up a big balance sheet and how difficult it would be to un-wind that. That sets up vulnerabilities in the financial sector, including stability issues.