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The Sveriges Riksbank Prize in Economic Sciences

11th October, 2022

 

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Context

  • The Royal Swedish Academy of Sciences has decided to award the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2022 to Ben S. Bernanke, Douglas W. Diamond and Philip H. Dybvig “for research on banks and financial crises”.
  • Their discoveries improved how society deals with financial crises.

 

Background and their Research

  • Modern banking research clarifies why we have banks, how to make them less vulnerable in crises and how bank collapses exacerbate financial crises. The foundations of this research were laid by Ben Bernanke, Douglas Diamond and Philip Dybvig in the early 1980s. Their analyses have been of great practical importance in regulating financial markets and dealing with financial crises.

 

Why Banks Exist

Diamond and Dybvig developed theoretical models that explain why banks exist, how their role in society makes them vulnerable to rumours about their impending collapse and how society can lessen this vulnerability.

  • For the economy to function, savings must be channelled to investments. However, there is a conflict here: savers want instant access to their money in case of unexpected outlays, while businesses and homeowners need to know they will not be forced to repay their loans prematurely.
  • In their theory, Diamond and Dybvig show how banks offer an optimal solution to this problem. By acting as intermediaries that accept deposits from many savers, banks can allow depositors to access their money when they wish, while also offering long-term loans to borrowers.
  • However, their analysis also showed how the combination of these two activities makes banks vulnerable to rumours about their imminent collapse. If a large number of savers simultaneously run to the bank to withdraw their money– a bank run occurs and the bank collapses. These dangerous dynamics can be prevented.
  • The laureates presented a solution to bank vulnerability, in the form of deposit insurance from the government. When depositors know that the state has guaranteed their money, they no longer need to rush to the bank as soon as rumours start about a bank run.
  • Thus, the solution is government providing deposit insurance and acting as a lender of last resort to banks.
  • Diamond also showed how banks perform a societally important function. As intermediaries between savers and borrowers, banks are better suited to assessing borrowers’ creditworthiness and ensuring that loans are used for good investments.

Bank runs

  • Ben Bernanke, analysed the Great Depression of the 1930s, the worst economic crisis in modern history. Among other things, he showed how bank runs were a decisive factor in the crisis becoming so deep and prolonged. When the banks collapsed, valuable information about borrowers was lost and could not be recreated quickly. Society’s ability to channel savings to productive investments was thus severely diminished.
  • Using historical sources and statistical methods, Bernanke’s analysis showed which factors were important in the drop in gross domestic product. He found factors that were directly linked to failing banks accounted for the lion’s share of the downturn.

 

Significance of their Research

  • The research presented by this year’s laureates in economic sciences reduces the risk of financial crises developing into long-term depressions with severe consequences for society, which is of the greatest benefit to us all.
  • This year’s laureates have significantly improved our understanding of the role of banks in the economy, particularly during financial crises.
  • The research has enhanced our understanding of banks, bank regulation, banking crises and how financial crises should be managed.
  • An important finding in their research is why avoiding bank collapses is vital. The laureates’ insights have improved our ability to avoid both serious crises and expensive bailouts.

 

Prize in economic sciences is not a Nobel Prize

The prize in economic sciences is not a Nobel Prize. In 1968, Sveriges Riksbank (Sweden’s central bank) instituted “The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel”, and it has since been awarded by the Royal Swedish Academy of Sciences according to the same principles as for the Nobel Prizes that have been awarded since 1901. The first prize in economic science was awarded to Ragnar Frisch and Jan Tinbergen in 1969.

 

Trivia

Abhijit Banerjee

  • In 2019, India-born American economist Abhijit Banerjee was awarded the Nobel Prize for economics (along with Esther Duflo and Michael Kremer) for helping to develop an innovative experimental approach to alleviating global poverty.

https://www.livemint.com/news/world/nobel-prize-2022-in-economics-awarded-to-ben-s-bernanke-douglas-w-diamond-and-philip-h-dybvig-11665387025568.html