Nobel Prize: Nobel prize for handymen, tailors, bankers

Ben Bernanke, Douglas Diamond and Philip Dybvig, winners of this year’s Nobel Prize in Economics, set out the principles that shape the health of modern banking, a critical intermediary in the world’s ability to weather financial catastrophe. The Diamond-Dybvig model describes the asset-liability mismatch inherent in banking, with businesses needing long-term loans and households saving over a much shorter period. Their theory explains why panics occur on banks and the role of deposit insurance. Bernanke’s work showed how bank runs contributed to the Great Depression.

The trio provided solutions to deal with financial crises, with Bernanke guiding the United States as chairman of the Federal Reserve between 2006 and 2014. Current Fed Chairman Jerome Powell served on the board of directors of Bernanke during the 2013 crisis and the Nobel laureate sees a desire not to rattle financial markets in his successor’s delay in acting on inflation following monetary accommodation in the face of the pandemic.

By describing why bank runs aren’t madness – random withdrawal of bank deposits works as long as there’s no reason to believe everyone is going to withdraw their money – the Diamond-Dybvig theory has been universally accepted by policy makers who view deposit insurance as a warning system and the role of the central bank as a lender of last resort.

This tends to synchronize the political response to financial imbalance and makes Bernanke’s plea for the Great Moderation – a decline in the intensity of the business cycle due to independent stabilization by central banks in advanced economies – a seductive and acceptable argument. . The era of low interest rates, however, created the conditions for financial institutions to take advantage of the off-balance sheet, which led to related defaults as the situation deteriorated. This triggered the 2008 crisis and a new set of macroprudential instruments was added to the policy mix to deal with rapid credit growth.

By giving credence to the macroeconomic framework, this year’s Nobel laureates have paved the way for new research on financial frictions that provides more robust modeling of economies.