On 10 October 2022, Ben Bernanke, Douglas Diamond and Philip Dybvig were awarded the prestigious Nobel Prize in Economic Sciences for significantly improving our understanding of the role of banks in the economy, particularly during financial crises. In the backdrop of the pandemic and ongoing conflicts distressing the world economy, their work is more relevant than ever.
Ben Bernanke
Ben Bernanke is a distinguished fellow at the Brookings Institution. He is perhaps best known for his role as the 14th Chair of the Federal Reserves, where he oversaw the organisation's response to the financial crisis of 2006-10. His Nobel-winning research expounded what drove a mild recession to develop into the Great Depression of the 1930s and revolutionised the way economists view financial crises. Prior to his work, the widely accepted rationale was put forward by Milton Friedman and Anna Jacobson Schwartz in their book ‘A Monetary History of the United States’. They explained that that in the early 1930s the failure of over 9,000 banks in the US created a state of panic, undermining confidence in the banking system. This resulted in a mass withdrawal of cash from depositors, increasing the currency held by the public. With both consumer spending and business confidence plummeting, output of the United States fell considerably. However, Bernanke argued that the contraction of money supply alone was not consequential enough to drive the ensuing fall in output. Another factor was at play - the ability to channel savings to productive investments. During the crisis, contraction of credit resulted in higher costs and lower availability of loans, which severely dampened economic activity, leading to the Great Depression. Among other things, he explained how bank runs and the consequent loss of information about borrowers can prolong a financial crisis.
Douglas Diamond and Philip Dybvig
Douglas Diamond is a professor of finance at the University of Chicago and Philip Dybvig is a professor of banking and finance at Washington University in St Louis. Among other things, their joint research focuses on the function of banks and their vulnerability to bank runs. In financial systems, savings are channelled to investments. The paradox that exists is that savers desire instant access to credit in the case of unexpected occurrences, whereas borrowers (businesses and homeowners) need the assurance that they wouldn’t have to repay their loans suddenly, or ahead of time. Diamond and Dybvig explain in their paper how banks act as intermediaries to solve this paradox. They also delve into the vulnerability of banks to bank runs and that government provided deposit insurance can alleviate this problem.
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