Nobel Prize in Economics

Syllabus: General Studies Paper 3

The Sveriges Riksbank Prize in Economic Sciences for 2022 was awarded to three American economists: Ben S Bernanke, Douglas W Diamond and Philip H Dybvi.

About Research

• Modern banking research clarifies why we have banks, how to make them less vulnerable in crises and how bank collapses exacerbate financial crises. 
• The foundations of this research were laid by Ben Bernanke, Douglas Diamond and Philip Dybvig in the early 1980s. 
• Their analyses have been of great practical importance in regulating financial markets and dealing with financial crises.
• The laureates’ insights have played an important role in ensuring crises such as covid pandemic did not develop into new depressions with devastating consequences for society.

Ben S Bernanke

• Bernanke demonstrated how failing banks played a decisive role in the global depression of the 1930s. The collapse of the banking system explains why the downturn was not only deep, but also long-lasting.
• It added the importance of well-functioning bank regulation.
• Conflict: 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. This creates the fundamental problem of volatility in banks and vulnerability to shocks such as in case of bank runs.
• 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.
• Interestingly, 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,”

Douglas W Diamond and Philip H Dybvi

• Both Diamond and Dybvig worked together to develop 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.
• The model captures the central mechanisms of banking, as well as its weaknesses. 
• It is based upon households saving some of their income, as well as needing to be able to withdraw their money when they wish. 
• That this does not happen at the same time for every household allows for money to be invested into projects that need financing.
• They argue, therefore, that banks emerge as natural intermediaries that help ease liquidity.
• But with massive financial crises that have been witnessed in history, particularly in the US, it is often discussed how banks need to be more careful about assessing the loans they give out, or how bailing out banks in crisis might turn out to be.

Miscellaneous

• A bank run may happen where many savers try to withdraw their money at once, which can lead to a bank’s collapse. For example, when people were unable to withdraw their money from a few rural banks in China earlier this year, they witnessed bank runs.