The Winners of the Nobel Economics Prize 2022
Who where the winners of the Nobel Economics prize of 2022? Why did they get awarded the prize in Economics? What are it's modern day uses?
By Julian Olsen-Pendergast
The Royal Swedish Academy of Sciences decided to award the Sveriges Riksbank Prize in Economic Sciences, in Memory of Alfred Nobel 2022, to Ben Bernanke, Douglas Diamond, and Philip Dybvig for their research into banks and financial crises.
At the time, we were unaware, but 15 years ago much of the world stood on the brink of a devastating economic crisis. Most were unprepared, but a few academic economists were both prepared and concerned. They had developed the theory of bank runs, believed in the evidence supporting it, and suspected that the possibility of runs was once again becoming relevant.
As events unfolded between 2008 and 2010, new evidence accumulated in support of the theory. In essence, the theory states that banks can be highly beneficial but are only guaranteed stability if they are properly regulated. In a 1983 paper, Bernanke demonstrated through statistical analysis and historical sources that bank runs led to bank failures. This mechanism transformed a relatively ordinary recession in the 1930s into the Great Depression.
Bernanke showed that banks need to remain operational during economic recessions and that the economy struggles to recover if they are not present. At the time, this analysis contradicted well-established economic beliefs. While economists observed bank failures, it was theorized that they were a consequence of the crisis rather than a cause.
In a 1983 paper titled "Bank Runs, Deposit Insurance, and Liquidity," Diamond and Dybvig demonstrated that banks are ideally structured to transfer savings into productive investments. Banks act as intermediaries, resolving the inherent conflict between savers and borrowers. They achieve this through maturity transformations but also highlighted the vulnerability of such transformations.
For example, if a rumor spreads that people will withdraw their money from a bank, everyone has an incentive to rush to withdraw their savings. As the bank has a limited amount of tangible assets, this can lead to bank failures. Hence, the importance of maturity transformation and its inherent vulnerability.
The research and analysis conducted by the laureates have significantly advanced our understanding of modern financial institutions and why they are susceptible to crises. They have provided a foundation for regulation and crisis management. Furthermore, their work on deposit insurance and its potential to mitigate bank runs has been groundbreaking.
These advancements in economics have proven invaluable over the past four decades, particularly during the 2008 financial crisis. The laureates' work has been fundamental in understanding the causes of the crisis. The urgency to comprehend the complex nature of financial markets to mitigate the risk of future crises is evident. Moreover, it showcases their remarkable foresight and understanding, as their work continues to be implemented 40 years later.
