Explained: Economics Nobel winners’ work on role of banks during financial crisis
- The trio's main work focused on understanding the role of banks in the economy, particularly during financial crises and how banking failures can amplify and self-perpetuate a crisis
The Nobel prize for Economics in 2022 was awarded to Ben S Bernanke, Douglas W Diamond and Philip H Dybvig on Monday for research on banks and financial crises. The economics prize is not one of the original five awards created in the 1895 will of industrialist and dynamite inventor Alfred Nobel.
It was established by Sweden's central bank and first awarded in 1969, its full and formal name being the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.
This year the trio who won the Nobel Prize in Economics helped the world understand the role of banks during a financial crisis. “Their discoveries improved how society deals with financial crises,” the Nobel committee said announcing the winners.
Understanding the research of Nobel prize for Economics
The trio's main work focused on understanding the role of banks in the economy, particularly during financial crises and how banking failures can amplify and self-perpetuate a crisis.
"An important finding in their research is why avoiding bank collapses is vital," the academy added. "Their analyses have been of great practical importance in regulating financial markets and dealing with financial crises."
The Academy said that Bernanke showed with statistical analysis that bank runs led to bank failures and this was the mechanism that turned a relatively ordinary recession into the depression in the 30s, the world's most dramatic, and, severe crisis.
Bank runs can easily become self-fulfilling leading to the collapse of an institution and putting the entire financial sector at risk.
"These dangerous dynamics can be prevented through the government providing deposit insurance and acting as a lender of last resort to banks," the Academy said.
Ben S Bernanke:- Bernanke was the head of the US central bank, the Federal Reserve, when the 2008 crisis hit, and was able to “put knowledge from research into policy,” the Academy said.
Bernanake's research highlighted the volatile relationship between the working of bank and the roll-out of money int he economy.
According to the press release, the research laid the foundation of some crucial questions on banks, “If banking collapses can cause so much damage, could we manage without banks? Must banks be so unstable and, if so, why? How can society improve the stability of the banking system? Why do the consequences of a banking crisis last so long? And, if banks fail, why can’t new ones immediately be established so the economy quickly gets back on its feet?”
“However, there is a conflict here: savers want instant access to their money in case of unexpected outlays, while businesses and homeowners need to know they will not be forced to repay their loans prematurely.” the release added
This lays out a fundamental problem that makes banks and money volatile and vulnerable to shocks sometimes. For example, when people were unable to withdraw their money from a few rural banks in China earlier this year, they witnessed bank runs. A bank run may happen where many savers try to withdraw their money at once, which can lead to a bank’s collapse.
Douglas W Diamond and Philip H Dybvig:-
Diamond and Dybvig 's research included developing theoretical models explaining why banks exist, how their role in society makes them vulnerable to rumours about their impending collapse, and how society can lessen this vulnerability.
“How the financial markets should be regulated to fulfil their function – channelling savings to productive investments without causing recurring crises – is a question that researchers and politicians continue to wrestle with. The research being rewarded this year, and the work that builds upon it, makes society much better equipped to take on this challenge,” the Academy noted, and added, “This reduces the risk of financial crises developing into long-term depressions with severe consequences for society, which is of the greatest benefit to us all.”
(With inputs from Reuters)
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First Published:10 Oct 2022, 06:17 PM IST
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