Prof. Ben S. Bernanke, the former chairman of the Fed and currently a researcher at the Brookings Institute in Washington, Douglas W. Diamond from the University of Chicago and Philip Dibwig, from Washington University in St. Louis, are the winners of the Nobel Prize for 2022, for their research in the field of the role of banks in economic crises.
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“Fifteen years ago the world faced a major economic crisis. Most of us were not prepared for it, but some economists were concerned. They studied the formation of economic crises and believed that one was on the horizon. Their theory said that banks are critical to our economic system, but they can to be stable only with proper regulation. And these researchers believed at the same time, that regulation is not enough,” it was said when the award was presented.
The studies of the three began in the 1980s, but the economic crisis of 2008 demonstrated how relevant they are. Bernanke, who was the chairman of the US central bank after serving as a professor at Princeton University, was the one who pointed out the banks and their possible collapse as an engine for economic crises, as opposed to the knowledge that was accepted before him, according to which the collapse of the banks is the result of the economic crisis.
Prof. Dibvig and Prof. Diamond studied the way in which banks allow for long-term investments while providing liquidity to savers in the short term, by balancing long-term investors with those who currently want immediate access to their money. But, when a feeling of uncertainty arises, a process of “attacking the banks” takes place, and everyone wants to spend the money at once. We have known this phenomenon from economic crises for hundreds of years, and the work of Dibvig and Diamond showed that this is an inherent weakness of the banking system, which is an integral part of the structure of our economy. They then showed what happens when governments try and sometimes succeed in bailing out banks, preventing these collapses, and how such events affect public confidence in banks and their risk of failing the next time.
Banks also hold information on business and private customers, which is intended to make sure that the public’s money is indeed channeled into efficient investments. In their research, the three researchers also referred to the information that banks have regarding business and private customers and showed that the collapse of banks also means a loss of information, which can harm the bank’s ability to conduct itself successfully in the future, and the possibility of the entire economy to quickly recover from the crisis.
The conclusion of these studies together, is that the collapse of banks must be prevented as a main tool for preventing economic crises.
Prof. Diamond: “It is not certain that it is worth preventing crises”
During the presentation of the award, a telephone conversation was held with Prof. Diamond, who in a rare way referred to the happenings in his field of research today.
Diamond pointed out that economic crises are related to events of uncertainty, which make the investing public want immediate access to their money. Rapid inflation like the one we see today, can be such an event of uncertainty. “Therefore it is very important that the banks be healthy, be perceived as healthy and be ready to respond quickly to changes.” He pointed out that in the previous crisis, the problems started within the banks and therefore the crisis was particularly bad. But, according to him, the experience from that crisis led to the strengthening of the banking sector, in a way that makes them more resilient today.
“It’s not just a matter of banks, but any situation where a certain entity has a debt that can be very liquid, and is much larger than the assets that are supposed to guarantee it,” he explained. “In the current situation, we will see things develop a little differently, because there are entities with this problem, but at least the banks themselves are in a better situation.”
He said he believed the national banks could succeed in bringing inflation back to its targets. According to him, it takes time for inflation to respond to monetary policy, so it should not surprise us very much that interest rates are currently rising and inflation is not stopping. He believes that the impact will be seen in the future, as long as the banks are determined in their decision that lowering inflation is their goal.
One of the questions from the audience was whether it was right to let Lehman Brothers collapse in 2008? Diamond replied that it was a tough question, but in the end he believed it was wrong to let the bank collapse in such a surprising way. A short time later came the collapse of AIG, and then there was an intervention, and since these two things happened together, and there was no escape from some kind of government intervention in the end, it might have been worthwhile to intervene in the Lehman Brothers case as well and let it collapse in a less dramatic way. But, he says, it is unclear to what extent American law really left the US central bank with the option to do so.
Diamond was asked if it is possible to prevent financial crises? And he replied that the work of the novelists can prove that it is possible to prevent financial crises, but it is not certain that it is worthwhile, because the prevention of crises creates new and deeper weaknesses in the system. Therefore, we will probably always have crisis events, but it is worthwhile to intervene so that they are more moderate.
Among the winners: the former chairman of the Fed
Bernanke, the winner who was chairman of the Fed as mentioned, is a member of a Jewish family, and he learned Hebrew as a child from his maternal grandfather, Harold Friedman, who was a cantor, butcher and Hebrew teacher. Evin and his uncle ran the family pharmacy founded by his paternal grandfather, Jones Bernanke. The Bernanke family came to the US in 1921, and lived through the economic crisis. Bernanke worked all his youth and during his studies, among other things in construction, waiters, sales and as an operator of facilities in an amusement park.
Nobel Prize Winner for Economics Ben Bernanke / Photo: Reuters, CHRISTOPHER ALUKA BERRY
He excelled in his studies, as well as a saxophone player, and taught himself advanced mathematics because his high school did not teach it. He was accepted to Harvard University in 1971, and studied economics, and completed his doctorate at MIT, under the guidance of Stanley Fishel, later Governor of the Bank of Israel.
Bernanke wrote in his book The Courage to Act, that if the US central bank had not worked to support the banks, the economic crisis of 2008 would have become a greater catastrophe than the great economic crisis of the US in 1939. However, Renanke was also criticized for his performance in the 2008 crisis, and for example an article in the New York Times said that he did not recognize the crisis early enough and that the support for the banks was too great. Winning the Nobel Prize will probably help soften some of this criticism.
The award is not distributed from the Nobel Foundation, but is equal to the other awards in terms of prestige
The Nobel Prize in Economics, or actually the “Alfred Nobel Prize in Economics”, is given by the Central Bank of Sweden. Unlike the other Nobel prizes, it is not distributed by the foundation established in the name of Alfred Nobel, the inventor of dynamite, which was established upon his death, but in terms of the level of prestige it is valued like the Nobel Prize, and is given together with the Nobel Prizes.
Last year, the prize was awarded to researchers who invented a new type of “randomized experiments”, as a replacement for the scientific method that randomly divides subjects into an experimental group and a control group. The goal in both cases, the controlled experiment and the “random experiment”, is to check what differences are created between two groups that start from exactly the same place, and then only one of them makes a single change. It is very difficult to do such manipulations on large enough groups in the real world, but sometimes two such groups naturally form – for example, when in the Vietnam War certain young people were drawn to be soldiers and others were not. Between the groups that advanced and did not advance in the lottery, there were no other fundamental differences at the beginning, but there were significant differences decades later, and they could be investigated.
Half of the award was given to Prof. David Card from the University of California at Berkeley, for his contribution to the empirical study of labor economics and the other half will be divided between Joshua D. Angrist from MIT University in Cambridge, USA and Guido Imbens from Stanford University in the USA, for their contribution to the development of methods for inferring cause and effect from their observational experiments – one of the biggest challenges in such experiments.
Israeli researchers or those with an Israeli past have relatively success in the Nobel Prize in Economics. Angrist, mentioned above, spent several years of his life in academia in Israel. Robert Israel Oman, the 2005 prize winner for his research in the field of game theory, is a researcher at the Hebrew University, and Daniel Kahneman, the 2002 winner for pioneering research in the field of behavioral economics, grew up in Israel and studied his first degrees at the Hebrew University.