At a time when the World Bank and the International Monetary Fund have warned of a possible global recession in 2023 and central banks have gone into overdrive to hike interest rates to control inflation, a trio of economists from the United States have won the 2022 Nobel Economics Prize for significantly improving "our understanding of the role of banks in the economy, particularly during financial crises".
At a time when the World Bank and the International Monetary Fund have warned of a possible global recession in 2023 and central banks have gone into overdrive to hike interest rates to control inflation, a trio of economists from the United States have won the 2022 Nobel Economics Prize for significantly improving "our understanding of the role of banks in the economy, particularly during financial crises".
The US trio of former US Federal Reserve Chairman Ben Bernanke, Douglas Diamond and Philip Dybvig have been awarded this year's Nobel Prize for economics for their research on regulating the financial sector and propping up failing banks to stave off economic crises.
Observing that their analysis has been of great "practical importance", the Nobel Committee added, "The actions taken by central banks and financial regulators around the world in confronting two recent major crises – the Great Recession and the Covid pandemic-induced slowdown – were in large part motivated by the laureates' research".
The Nobel Prize Committee's words are yet another validation for Bernanke, the former chief of the US Fed when the financial crisis began in 2008, and faced criticism for the bank bailouts that triggered a public backlash. However, Bernanke, a scholar of the Great Depression, believed that the economy could be saved by saving the existing financial system.
He has been credited for using innovative methods to protect the financial system from failing, including bringing the interest rate near zero for the first time in Fed history and initiating widespread quantitative easing (the central bank buying government securities and assets to stimulate the economy).
"He (Bernanke) played a decisive role in stabilising the US and global economies," Reuters quoted Mark Carney, former chief of Canada's central bank, saying in 2013.
Mr Bernanke is undoubtedly one of the most high-profile award winners – perhaps the first ex-Fed chief to win the prize. Nevertheless, the contribution of Douglas Diamond and Philip Dybvig, both frequent collaborators and the namesake of the Diamond–Dybvig model, are invaluable as they laid down the theoretical basis for bank runs and financial crises.
Diamond, who is associated with Chicago University, and Dybvig, a professor at Washington University in St. Louis, in 1983 postulated that the liquidity needs of savers clash with the borrowers who want to take long-term loans. This, the model says, is a source of tension for banks.
In a normal situation, banks allow savers to access their savings. At the same time, borrowers get their loans with a long maturity, while many savers rushing to withdraw their savings could lead to a bank collapse.
Their analyses showed that the government (central bank in the modern sense) acting as a lender of the last resort could help protect the banking system. Finally, as an intermediary, they argued, banks can analyse borrowers' creditworthiness and avoid 'bad loans' as much as possible.
'Bad loans' (read subprime loans in the US) were one of the triggers for the 2008 global financial crisis and led to the collapse of banks worldwide.
Raghuram Rajan, former Reserve Bank of India chief, has paid a rich tribute to the duo in a LinkedIn post, calling Diamond the "father of modern banking theory." He added that their papers also influenced Bernanke to make the Diamond-Dybvig model a required reading while the Fed grappled with the financial crisis.
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