STOCKHOLM (AP) — Former Federal Reserve Chairman Ben Bernanke, who used his academic expertise on the Great Depression to revitalize America’s economy after the 2007-2008 financial crisis, won the Nobel Prize in economics along with two other US residents People economists for their research on bank failures.
The Nobel Panel of the Royal Swedish Academy of Sciences on Monday recognized Bernanke, Douglas W. Diamond and Philip Dybvig for their research showing “why avoiding bank failures is crucial”.
Their findings in the early 1980s laid the groundwork for the regulation of financial markets, the panel says.
“Financial crises and depressions are the worst thing that can happen to the economy,” said John Hassler of the Economics Awards Committee. “We need to understand the mechanism behind it and what we can do about it. And that’s what this year’s award winners offer.”
Bernanke, 68, studied the Great Depression of the 1930s when he was a professor at Stanford University, showing the danger of bank runs – when people panic withdraw their savings – and how bank failures led to widespread economic devastation. He was Fed Chairman from early 2006 to early 2014 and is now at the Brookings Institution in Washington.
Before Bernanke, economists saw bank failures as a consequence, not a cause, of economic downturns.
Diamond, 68, of the University of Chicago, and Dybvig, 67, of Washington University in St. Louis, showed how government guarantees on deposits can prevent a spiral of financial crises.
“Probably the most encouraging thing for us is that policymakers seem to actually get it and the insights we had, which are pretty straightforward, could be used in the current financial crisis,” Diamond told The Associated Press in Chicago. He added that he was “very happy” and “quite surprised” to get the call.
When it comes to the global economic turmoil caused by the COVID-19 pandemic and Russia’s war in Ukraine, memories of the 2000s collapse and improved regulation have made the financial system ‘much, much less vulnerable’ for crises, Diamond said in an appeal with the Nobel panel.
The trio’s research took on real meaning when investors panicked the financial system in the fall of 2008, triggering the longest and most painful recession since the 1930s.
Bernanke, then Fed chief, partnered with the US Treasury to prop up big banks and ease the credit crunch, the lifeblood of the economy.
He cut short-term interest rates to zero, directed the Fed’s purchases of Treasuries and mortgage investments, and instituted unprecedented lending programs. Overall, these moves reassured investors and bolstered the big banks — and they were credited with avoiding another depression.
The Fed also pushed long-term interest rates to historic lows, prompting criticism of Bernanke, particularly from some 2012 Republican presidential candidates who said the Fed was hurting the dollar’s value and risking fomenting inflation later.
And Bernanke’s unprecedented activism at the Fed set a precedent for the central bank to respond swiftly and vigorously to economic shocks.
As COVID-19 wreaked havoc on the US economy in early 2020, the Fed, chaired by Jerome Powell, quickly cut short-term interest rates back to zero and pumped money into the financial system. Aggressive intervention – coupled with massive government spending – quickly ended the downturn and sparked a strong economic recovery.
But the quick comeback came at a price: Inflation started surging last year and is now near 40-year highs, forcing the Fed to reverse course and hike rates to cool the economy. Central banks around the world are taking similar steps as inflation erodes consumer purchasing power.
In a seminal 1983 paper, Bernanke examined the role of bank failures in deepening and prolonging the Great Depression of the 1930s.
Previously, economists blamed the Fed for not printing enough money to prop up the economy as it slumped. Bernanke agreed, but noted that the lack of money could not explain why the Depression was so devastating and lasted so long.
The problem, he felt, was the collapse of the banking system. Panicked savers pulled money out of struggling banks, which then failed to lend to keep the economy growing.
“The result,” the Nobel Committee wrote, “was the worst global recession in modern history.”
“Ben Bernanke’s 1983 essay was stunningly original and of enduring relevance — not to explain how the Great Depression began, but to explain why it lasted so long,” said Alan Blinder, former Fed vice chairman, economist at Princeton University. “This insight has influenced the thinking of economists ever since.”
Diamond and Dybvig showed that banks play a crucial role in solving a vexing financial problem: savers want instant access to their money, but businesses need time to see their businesses turn a profit before they can fully repay loans. In a 1983 publication, Diamond and Dybvig examined the key role of banks as intermediaries between savers and borrowers.
They also found that banks are vulnerable: when savers fear their bank may fail, they withdraw their money, forcing the bank to borrow money to raise money for withdrawals. To stop bank runs – and their economic consequences – governments can insure deposits and act as lenders of last resort for banks.
The finding: “If the panic could be prevented, banks would be fine,” says Simon Johnson, an economist at the Massachusetts Institute of Technology who wrote about the financial crisis. “It’s a very, very powerful idea that underpins how people think about financial stability.”
Diamond also noted in a 1984 paper that banks play a crucial role in assessing borrowers’ creditworthiness and ensuring that loans go to worthy projects and are repaid.
The business prize crowned a week full of Nobel Prize announcements in medicine, physics, chemistry, literature and peace. They are endowed with 10 million Swedish kronor (almost 900,000 US dollars) and will be presented on December 10th.
Unlike the other prizes, the Economic Prize was not donated in Alfred Nobel’s 1895 will, but by the Swedish Central Bank in his memory. The first winner was selected in 1969.
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Jordans reported from Berlin and Wiseman from Washington. AP video journalist Teresa Crawford in Chicago contributed.
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