The Nobel Memorial Prize in Economic Sciences was awarded Monday to Ben Bernanke, the former Federal Reserve chair, and two other academics who have helped to reshape how the world understands the relationship between banks and financial crises.
Douglas W. Diamond, 68, of the University of Chicago and Philip H. Dybvig, 67, of Washington University in St. Louis — two economists who created a seminal model that explained the dynamics of bank runs and financial meltdowns — won the prize alongside Bernanke, 68, who is now at the Brookings Institution in Washington.
The three economists won for a body of work that stretches back to the 1980s. Their research has delved into different aspects of how banks become vulnerable to upheaval, how bank failures worsen and extend financial disasters, and how the system might be made safer in light of those risks.
These findings have repeatedly proved relevant to real-world policy, with central bankers drawing on their lessons in 2008 during the financial meltdown and in 2020 when markets seized up at the start of the pandemic. Those policymakers included Bernanke, who was the Fed chair from 2006 to 2014.
And the research could soon become pertinent again. Central banks around the world are raising interest rates at a rapid pace to combat a burst of inflation, which is causing markets to shudder and has already contributed to a meltdown in one corner of the financial system in Britain that required emergency intervention.
The new laureates’ work proved “highly relevant in the great financial crisis in 2008 and 2009,” said Mark Gertler, a New York University economist who has written articles with Bernanke. “It’s also relevant now, as interest rates are going up, and we’re starting to see stress in financial markets.”
The Nobel committee cited the economists’ early research, including Bernanke’s influential 1983 paper that explained how bank failures can propagate a financial crisis rather than simply be a result of one. He drew on his work on financial crises while at the Fed, fighting the worst downturn the United States had faced since the Great Depression. It was a “practical application” of his research, he said at a news conference Monday hosted by the Brookings Institution after the awards were announced.
Bernanke said he and his colleagues at the Fed had worked hard to prevent a broader financial meltdown. “I strongly believed that if that happened, that would bring down the rest of the economy,” he said, adding of his research, “It did help me to think about these issues in 2008.”
When the housing market began tumbling around that time, overextended borrowers fell behind on mortgages and a pile of risky loans parceled out across big banks and other institutions began to drag down the financial system. Bernanke helped set up emergency programs to prevent markets from collapsing and, alongside the Treasury Department, used the Fed’s powers to enable bailouts of bank and insurance company portfolios.
That downturn provided an example of just how damaging bank failures could be to the real economy. The Fed and Treasury allowed Lehman Brothers to collapse, which Bernanke has said he and his colleagues believed was their only option. Some critics have since argued that the investment bank could and should have been saved, and it is widely accepted that the ripple effects of that failure worsened the downturn, which reverberated around the world.
Louise Sheiner, the policy director for the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution, wrote in an email that she was “absolutely thrilled” at Bernanke’s award. “He represents the ideal combination of someone who cares greatly about the real world, has a deep understanding of how it works, using both real experiences and the insights that he gets from his and others' research, and the confidence and courage to take actions that go beyond the frontier of academic research when it seems necessary.”
Diamond and Dybvig wrote in 1983 about the risks inherent in maturity transformation, or the process in which banks turn short-term borrowing into long-term lending. They showed how that setup subjects banks to sudden, panicked withdrawals by customers if there is no deposit insurance or other protection.
The research remains “one of the clearest and beautiful papers in modern economics,” said Kenneth Rogoff, an economist at Harvard University.
Diamond also wrote about how banks monitor their borrowers, noting that knowledge about borrowers disappears when banks fail, making the upheaval worse.
“The laureates have provided a foundation for our modern understanding of why banks are needed, why they’re vulnerable and what to do about it,” John Hassler, an economist at the Institute for International Economic Studies at Stockholm University and a member of the prize committee, said during the news conference announcing the prize.
Diamond spoke by phone at the conference. Asked whether he had any warnings for banks and governments today, given recent market turmoil, Diamond said financial crises become worse when people begin to lose faith in the stability of the system.
“In periods when things happen unexpectedly — like, I think many people are surprised how rapidly nominal interest rates have gone up around the world — that can be something that sets off fears in the system,” he said. “The best advice is to be prepared, for making sure that your part of the banking sector is both perceived to be healthy, and to stay healthy, and respond in a measured and transparent way to changes in monetary policy.”
Dybvig did not respond to an emailed request for comment on his prize.
The three economists’ research findings “reinforce each other,” the Nobel committee said in its background documents on the prize. “Together they offer important insights into the beneficial role that banks play in the economy, but also into how their vulnerabilities can lead to devastating financial crises.”
Diamond said at the news conference that the world is better poised for any financial upheaval now than it was during the financial crisis in 2008, because “recent memories of that crisis” and regulatory improvements have made the banking system less vulnerable.
Still, the weaknesses that he and Dybvig have identified extend beyond banks and can bubble up in other parts of the financial system, such as insurance firms or mutual funds, he noted.
Bernanke was also asked about how the three men’s research applies to the current moment.
“We’re certainly not in anything like the dire straits we were in 14 years ago,” Bernanke said of the state of the U.S. financial system. Still, he noted that “it is true that even if financial problems don’t begin an episode, over time” they “can add to the problem, and intensify it — so that’s something, I think, that we really have to pay close attention to.”
And asked for advice from younger economists, Bernanke seemed to allude to the twists his career took, from researching financial crises to steering the world’s largest economy through one.
“One of the lessons of my life is, you never know what is going to happen,” he said.
This article originally appeared in The New York Times.
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