Former Federal Reserve Chairman Bernanke shares Nobel prize for bank failure research

STOCKHOLM — Former Federal Reserve Chairman Ben Bernanke and two other U.S.-based economists have won the Nobel Prize in Economics for their research on bank failures — work that builds on lessons learned from the Great Depression and helped shape America’s aggressive response to the 2007-2008 financial crisis.

The Nobel Prize jury of the Royal Swedish Academy of Sciences on Monday recognized Bernanke, Douglas W. Diamond and Philip Dybvig for their research which shows “why avoiding bank failures is vital”.

Their findings in the early 1980s laid the groundwork for regulating financial markets, the panel said.

“Financial crises and depressions are sort of the worst thing that can happen to economics,” said John Hassler of the Economics Prize Committee. “We need to understand the mechanism behind these and what to do about it. And this year’s winners provide that.”

Bernanke, 68, examined the Great Depression of the 1930s when he was a professor at Stanford University, showing the danger of bank runs – when panicked people withdraw their savings – and how bank meltdowns led to economic devastation widespread. He served as Fed chairman from early 2006 to early 2014 and now works at the Brookings Institution in Washington.

Prior to Bernanke, economists viewed bank failures as a consequence, not a cause, of economic downturns.

Diamond, 68, based at the University of Chicago, and Dybvig, 67, based at Washington University in St. Louis, showed how government guarantees on deposits can prevent a spiral of financial crises.

“Probably the most gratifying thing for us is that the policy makers seem to actually get it, and the ideas that we had, which are quite simple, could be used in the current financial crisis,” Diamond told The Associated Press at Chicago.

Regarding the global economic turbulence created by the COVID-19 pandemic and Russia’s war in Ukraine, the financial system is “much, much less vulnerable” to crises due to memories of the 2000s collapse and regulatory improvement, Diamond said in a call. with the Nobel jury.

The trio’s research took on real significance 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, teamed up with the US Treasury Department to support big banks and ease the credit crunch, the engine of the economy.

He cut short-term interest rates to zero, led the Fed’s purchases of Treasuries and mortgage investments, and implemented unprecedented lending programs. Collectively, these measures calmed investors and strengthened the big banks – and have been credited with averting another depression.

The Fed also pushed long-term interest rates to historic lows, prompting strong criticism of Bernanke, particularly from some 2012 Republican presidential candidates who said that the Fed was hurting the value of the dollar and risking triggering inflation later.

And Bernanke’s unprecedented activism at the Fed set a precedent for the central bank to respond quickly and forcefully to economic shocks.

When COVID-19 hit the US economy in early 2020, the Fed, under Chairman Jerome Powell, quickly cut short-term interest rates to zero and pumped money into the financial system. . The aggressive intervention – accompanied by massive government spending – quickly ended the downturn and sparked a powerful economic recovery.

But the quick comeback has also come at a cost: Inflation began to rise rapidly last year and is now near 40-year highs, forcing the Fed and other central banks to reverse course and hike rates. to cool the economy.

At a press conference on Monday, Bernanke expressed confidence in current Fed Chairman Jerome Powell and his former central bank colleagues, but said they faced “a very difficult challenge.” trying to bring the economy to a so-called soft landing: raising interest rates just enough to cool the economy and control inflation without triggering a recession.

Bernanke said he and his wife turned off their cell phones last night and learned of the Nobel Prize when their daughter called with the news.

In a groundbreaking 1983 article, Bernanke explored the role of bank failures in deepening and lengthening the Great Depression of the 1930s.

Before that, economists blamed the Fed for not printing enough money to support the economy as it sank. Bernanke agreed but found that lack of money could not explain why the Depression was so devastating and lasted so long.

The problem, he discovered, was the collapse of the banking system. Panicked savers withdrew money from failing banks, which then could not provide the loans that allowed the economy to grow.

“The result,” the Nobel committee wrote, “was the worst global recession in modern history.”

“Ben Bernanke’s 1983 article was startlingly original and of enduring significance – not for explaining how the Great Depression began, but for explaining why it lasted so long,” said the former vice president of the Fed, Alan Blinder, economist at Princeton University. “This idea has affected the thinking of economists ever since.”

Diamond and Dybvig showed that banks play a crucial role in solving a tricky financial problem: savers want instant access to their money, but companies need time to see their businesses turn a profit before they can repay. their loans in full. In a 1983 article, Diamond and Dybvig explored the key role of banks as intermediaries between savers and borrowers.

They also found that banks are vulnerable: if savers fear their bank is in danger of bankruptcy, they will withdraw their money, forcing the bank to take out loans to raise funds to cover the withdrawals. To stop bank runs – and their economic fallout – governments can insure deposits and act as a lender of last resort for banks.

The idea: “If you could prevent the panic, then the banks would be fine,” said Simon Johnson, an economist at the Massachusetts Institute of Technology who has written about the financial crisis. “It’s a very, very powerful idea that underpins the way people think about financial stability.”

Diamond also established, in a 1984 paper, that banks play a crucial role in assessing the creditworthiness of borrowers and ensuring that loans go to worthwhile projects and are repaid.

The economics prize capped a week of Nobel Prize announcements in medicine, physics, chemistry, literature and peace. They carry a cash prize of 10 million Swedish crowns (nearly $900,000) and will be awarded on December 10.

Unlike other prizes, the Economics Prize was not created in Alfred Nobel’s will of 1895 but by the Swedish central bank in his memory. The first winner was selected in 1969.

Jordans reported from Berlin and Wiseman from Washington. AP video reporter Teresa Crawford in Chicago contributed.