Former Fed chairman Ben Bernanke and two other US-based economists – Douglas Diamond and Philip Dybvig – have won the Nobel Prize in economics for research on banks and financial crises. Announcing the award, the Royal Swedish Academy of Sciences said their discoveries have significantly improved understanding of the role of banks in the economy, particularly during financial crises. An important finding in their research is why avoiding bank collapses is vital, the academy said.
The prize amount is 10 million Swedish kronor, which will be shared equally between the three.
Born in 1953, Bernanke did his PhD from the Massachusetts Institute of Technology, Cambridge in 1979. He served as the 14th chairman of the US Federal Reserve from 2006 to 2014. Bernanke was the key architect of the bailout plan that was brought in to rescue America from the 2008 subprime financial crisis.
As chairman, he led the Fed’s response to the financial crisis. During his stint, the Fed took unprecedented steps to implement quantitative easing, a process whereby the central bank purchased billions of dollars of mortgage-backed securities and long-term treasuries to stimulate economic growth. It was under his tenure, the Fed adopted a formal inflation target of 2 per cent.
Detailing his contribution, the academy said Bernanke analysed the Great Depression of the 1930s, the worst economic crisis in modern history. He showed how bank runs were a decisive factor in the crisis becoming so deep and prolonged. When the banks collapsed, valuable information about borrowers was lost and could not be recreated quickly.
For the economy to function, the academy added, savings must be channelled into investments. However, there is a conflict here: account holders 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.
In their theory, Diamond and Dybvig show how banks offer an optimal solution to this problem. By acting as intermediaries that accept deposits from many savers, banks can allow depositors to access their money when they wish, while also offering long-term loans to borrowers.
However, their analysis also showed how the combination of these two activities makes banks vulnerable to rumours about their imminent collapse. If a large number of savers simultaneously run to the bank to withdraw their money, the rumour may become a self-fulfilling prophecy – a bank run occurs and the bank collapses.
Diamond demonstrated how banks perform another societally important function. As intermediaries between many savers and borrowers, banks are better suited to assessing borrowers’ creditworthiness and ensuring that loans are used for good investments, the academy said.