Banks in Financial Crises: For what was the Nobel Prize in Economics awarded this year?
Nov 30, 2022
4 min read
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This year, three Americans won the Nobel Prize in Economics — Ben Bernanke, Douglas Diamond and Philip Dybvig, who researched banks and financial crises. Why their research is so important to understanding economics is explored in today's blog.
The work of the Nobel laureates is related to understanding the role banks play in the economy and why avoiding bank failures is vital in times of crisis. In the 1980s, their research became fundamental to the regulation of financial markets. According to members of the Nobel Committee, understanding the mechanisms of resisting financial crises and depressions is a meaningful tool for overcoming them.
Ben Bernanke, formerly head of the U.S. Federal Reserve, researched bank failures during the Great Depression in the United States. By the time his major works appeared, bank failures were thought to be a consequence of the crisis, not its cause. Economists blamed the 1930s crisis on the Fed for the shortage of cash in bank branches, but according to Bernanke's findings, this is what cannot explain the devastating force of the Great Depression. The biggest problem, according to the laureate, was bank panic, because the almost simultaneous withdrawal of a large amount of savings was the cause of the further crisis. This led to an inability of credit to the public and a further global recession.
Douglas Diamond and Philip Dibvig, American economists, in their academic papers back in the early 1980s, have been working out how government deposit guarantees can prevent financial crises. The global financial crisis of 2008 helped put Diamond and Dibvig's work to the test. At that time, the head of the FRS was Ben Bernanke, who together with the U.S. Treasury made a number of strategic decisions to help the banking system. New lending programs were created, short-term interest rates were reduced to zero, and long-term rates were lowered to unprecedented levels. At the same time, investment purchases were managed manually by the Federal Reserve. All of this helped relieve the credit shortage and the big banks, on which the economy was hanging on, stood firm, which reassured investors. The crisis was not avoided, but it is generally accepted that the FRS, under Bernanke's leadership, did everything it could to prevent a repeat of the Great Depression.
Their research, which has been going on since the 1980s, has indeed had not only theoretical but also practical value, expanding the ability of several generations of financiers and policymakers to avoid and prevent global crises. A functioning economy requires the attraction of savings into investment, but depositors prefer to always be able to get their money back, and borrowers want the assurance that they will not be forced to pay back their loans prematurely. Thanks to the work of Diamond and Dibwig, banks have been able to offer the best possible solutions to these problems. In doing so, it is obvious how banks are vulnerable in the face of panic. With mass hysteria, people go to withdraw funds from banks, which contributes to their collapse. But if the government acts as a guarantor of funds insurance — this dangerous trend may well be reversed.
An analogy can be drawn with the current situation in Ukraine. The government took many steps to reduce panic in the foreign exchange market, gave guarantees of insurance of funds, and regularly issued war bonds to attract new investment, thus ensuring the stability of the banking system. Therefore, we can see how the practices of American economists have come in handy for us during the crisis provoked by the war.
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