Former Federal Reserve chair Ben S. Bernanke, Douglas W. Diamond of the University of Chicago and Philip H. Dybvig of Washington University in St. Louis were awarded the Nobel Memorial Prize in Economic Sciences on Monday for their work on banks and financial crises.
“Their discoveries improved how society deals with financial crises,” the committee said, crediting the academics for showing policymakers it is critical to prevent banks from failing.
Bernanke, who led the Fed during the 2008 financial crisis, was recognized for his pathbreaking 1983 analysis of the Great Depression. The committee said his research showed how bank runs had turned an ordinary recession in the 1930s into the worst global economic crisis in history.
Bernanke demonstrated that bank failures — rather than resulting from the downturn — were responsible for making it so deep and so long. When banks collapsed, valuable information about borrowers disappeared, making it difficult for new institutions to channel savings to productive investments, the committee said.
During the 2008 crisis, Bernanke piloted the Fed to an expansive use of central bank powers, dropping interest rates to near zero and accumulating assets worth a then-record $4 trillion in a bid to spur economic activity.
The former Fed chief, now affiliated with the Brookings Institution, said he learned of the award this morning in a phone call from his daughter.
“It was completely unexpected," he told reporters. “My wife and I shut off our cell phones when we went to bed last night, not thinking about this issue, and it was our daughter in Chicago who was finally contacted and called us on the landline to inform us this had happened.”
Diamond and Dybvig were honored for pioneering theoretical work, also in 1983, which explained banks’ role in linking savers and borrowers in a mutually beneficial relationship.
The two men showed how banks resolve an inherent conflict between those with excess funds at any one time and those who need more cash than they have. Savers want immediate access to their money in case of unexpected expenses, while borrowers want the assurance that they will not be forced to repay their loans prematurely, the committee said.
By acting as a middle man, banks pool savings from multiple individuals, allowing them to satisfy savers’ demands for easy access to their deposits while providing long-term loans to businesses and others.
Diamond and Dybvig also showed how banks’ essential function leaves them vulnerable to rumors of potential collapse. If savers grow worried that a bank is about to fail, withdrawals can snowball into a destabilizing and self-fulfilling “run” on the bank. That dire outcome can be avoided, as it is in the United States, by having the government offer deposit insurance that protects savers against such losses and by having the central bank operate as a lender of last resort.
Diamond also was recognized for his 1984 work showing that banks play a vital role by amassing valuable information about borrowers, assessing their creditworthiness and ensuring that loans are used for sound ventures.
The award committee woke Diamond with the news of his Nobel and patched him in to the ceremony.
“It did come as a surprise,” Diamond said by phone. “I was sleeping very soundly.”
The three economists will split the prize money of 10 million Swedish kronor, or roughly $885,810.
The award comes as world financial leaders are preparing for this week’s annual meeting of the International Monetary Fund and World Bank in Washington, with the global economy slowing amid high inflation.
Though current conditions bear little resemblance to the 2008 crisis that he managed at the Fed, Bernanke said that financial risks can emerge without warning.
“Even if financial problems don’t begin an episode, over time if the episode makes financial conditions worse, they can add to the problem and intensify it,” he said. “So I think that’s really something we have to play close attention to.”
Speaking by phone, Diamond told reporters in Stockholmthat the financial system is better armored today than in 2008, and he predicted that central banks will succeed in controlling inflation.
He also said that efforts to design an invulnerable financial system would interfere with its core function of creating liquid, or readily available, assets out of illiquid ones.
“It’s possible, but not necessarily desirable” to seek such perfection, he said.
The award ceremony was streamed live on the Nobel institution’s website.
Before Monday’s announcement, a total of 89 individuals had received the prize, known formally as the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.
Last year’s prize was split between David Card of the University of California at Berkeley, who received one-half of the award, and two other economists, Joshua Angrist of the Massachusetts Institute of Technology and Guido Imbens of Stanford University, for their work drawing conclusions by observing the cause and effect of real-world economic actions.