As the Royal Swedish Academy of Sciences announced on 10 October, the three US economists Ben Bernanke, Douglas Diamond, and Philip Dybvig will be awarded the Nobel Prize in Economics for their research on banking and financial crises.
In their work, the economists have contributed significantly to a better understanding of the close ties between banking and economic crises. As a consequence, political leaders have been able to take the right decisions during times of crisis. “It was an important result of their research to illustrate why preventing banks from collapsing was of crucial relevance”, as the Royal Swedish Academy pointed out in its statement.
The connection of banking and economic crises
The Committee explained that the three US researchers had provided key insights into the tasks, the functioning, and the vulnerability of banks to crises. The question why banking crises tend to come with long-term effects and can have a lasting impact on the economic development of the affected countries was a particularly important aspect. The research, dating largely back to the 1980s, concludes that financial crises worsen as soon as the people lose their trust in the stability of the system. The scientists thus supported the hypothesis that preventing banks from collapsing was of preeminent importance so as to keep a negative spiral from dragging down the economy.
Financial crisis 2008 as litmus test
When, some 15 years ago, the investment bank Lehman Brothers filed for bankruptcy, one banking crash was followed by another, with the world holding its breath. It was a dramatic moment that almost nobody was prepared for – except for a few scientists, one of whom was chair of the US Fed then: Ben Bernanke. Their insights played a decisive part in getting the situation ultimately under control. It was known that banks were in imminent trouble if customers were suddenly withdrawing their savings in fear of a bank insolvency. The dangerous momentum of such a bank run was stopped by the fact that several states reacted by issuing a deposit guarantee, ensuring that the money on private accounts was safe. The know-how gained by the three US economists was also of great value during the corona virus pandemic.
Understanding crises – mastering crises
Ben Bernanke as well as Douglas Diamond and Philip Dybvig analysed the background and particularities of financial and economic crises in their research.
- In his studies, Ben Bernanke focused in particular on the Great Depression of the 1930s and was of the opinion that it had been caused by bank runs. Employing statistical methods, he proved that the situation only improved once the government stepped in to prevent further bank panics.
- Douglas Diamond and Philip Dybvig were able to illustrate in their research the susceptibility of banks to rumours about a collapse and at the same time suggest ways in which governments could prevent this worst case from unfolding
Why did the jury nominate precisely these three economists for the Nobel economics prize? The Royal Swedish Academy of Sciences points out that they have drastically improved our understanding of the role of banks in our economy, especially during the financial crisis. They also pointed out ways in which the financial markets could be regulated.