Three economists from the United States claim the prestigious award in Economics this year. Ben Bernanke, Douglas Diamond and Philip Dybvig share the 2022 Nobel Memorial Prize in Economic Sciences for their research on banks and their role in a financial crises. One of the major takeaways from their research is why avoiding bank collapses is vital.
Some interesting history about this award in Economics….
Interestingly, the Sveriges Riksbank Prize in Economic Sciences was not established in the 1895 will of Afred Nobel and as weird as it may sound to you, “it is NOT a Nobel Prize”. It was established much later by the Swedish Central Bank in the year 1968 in the memory of Alfred Nobel. So the first Nobel Memorial Prize in Economic Sciences was awarded to Ragnar Frisch and Jan Tinbergen in 1969.
Coming back to the Prize in 2022
The prize this year rewards foundational research on the role of banks in the economy, particularly during financial crises. Financial intermediaries such as traditional banks and other institutions like banks facilitate loans between lenders and borrowers, thereby playing a key role for the allocation of capital. They enable the middle class to buy a home by mortgage, famers to buy agricultural machines and firms to acquire factories on loans. But apart from all this, these financial intermediaries also play a key role during times of economic distress.
In this era of digital payments, all of us are bound to have some or the other kind of relation to banks. So, in crises, if important banks collapse then borrowing becomes difficult and expensive for its customers, which is followed by the property prices shooting up. If this chain of events is not interrupted, the entire economy can enter a downward spiral of rapidly increasing unemployment and bankruptcies.
So can we manage to function without banks and how can we maintain economic stability?
It was in the early 1980s that Ben Bernanke, Douglas Diamond and Philip Dybvig laid the scientifc foundation for modern research into these issues in a series of three articles.
Diamond and Dybvig developed theoretical models that explain why banks exist, how their role in the society makes them vulnerable to any rumours about their impending collapse and how the society can reduce this vulnerability. These insights form the foundation of modern bank regulation used in the present age.
Diamond’s model explains how the existence of banks leads to a reduction in the cost of transferring savings to productive investments, known as the cost of credit intermediation. This cost reduction allows a larger number of societally valuable investment projects to be financed. In case many banks fail at the same time, such as during the depression of the 1930s, the cost of credit intermediation increases so dramatically that much of the economy stops functioning. The act of monitoring requires knowledge that is completely lost when a bank fails, and this knowledge takes time to recreate. The consequences of bank failures are therefore not only extremely negative, but also long term.
Whereas Bernanke, using statistical and historical analysis, established the decisive role of collapse of banks in the “Great Depression of the 1930s”, the effects of which were not only deep but long-lasting too. In particular, he showed that the economic downturn became so deep and so protracted in large part because bank failures destroyed valuable banking relationships, and the resulting credit supply contraction left significant scars in the real economy. His study thus solidified the models proposed by Diamond and Dybvig.
Take home message
Research alone cannot settle the debate about how the financial markets should be regulated. This 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. 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.
For more detailed information, you can read the attached Advanced Scientific Description herewith.
What about the rest of the Nobel Prizes awarded in 2022?
Nobel Prize Winner Svante Paabo | Nobel Prize In Physiology or Medicine 2022
Nobel Prize In Physics 2022 | Alain Aspect, John Clauser And Anton Zeilinger Win Physics Nobel
Nobel Prize In Chemistry 2022 | Sharpless For The Second Time
Akshat Mishra holds a Masters in Physics from DAE - Centre for Excellence in Basic Sciences, Mumbai. He feels the need to explore the depths of the not-so-dark universe while at the same time watch the quanta in action. Electronic Music is what puts him in the thinking zone.