Former Fed Chair Bernanke shares Nobel for research on banks

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

The Nobel panel at the Royal Swedish Academy of Sciences recognized Bernanke, Douglas W. Diamond and Philip Dybvig on Monday for research that shows “why avoiding bank collapses is vital.”

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

“Financial crises and depressions are kind of the worst thing that can happen to the economy,” said John Hassler of the Committee for the Prize in Economic Sciences. “We must understand the mechanisms behind them and how to fix it. And the laureates this year 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 collapses led to widespread economic devastation. He was the Fed chair from early 2006 through early 2014, and is now at the Brookings Institution in Washington.

Economists considered bank failures to be a result, not a cause of economic downturns before Bernanke.

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 spiraling of financial crises. Perhaps the most gratifying aspect for us is how policymakers seem to understand it. The insights that we had, which were pretty simple, could have been used in the actual financial crises,” Diamond said to The Associated Press in Chicago.

When it comes to the global economic turmoil created by the COVID-19 pandemic and Russia’s war in Ukraine, the financial system is “much, much less vulnerable” to crises because of memories of the 2000s collapse and improved regulation, Diamond said in a call with the Nobel panel.

The trio’s research took on real-world significance when investors sent the financial system into a panic during fall 2008, prompting the longest and most painful recession since the 1930s.

Bernanke, then head of the Fed, teamed up with the U.S. Treasury Department to prop up major banks and ease a shortage of credit, the lifeblood of the economy. He slashed short term interest rates to zero, directed Fed purchases of Treasury and mortgage securities, and created unprecedented lending programs. These steps collectively calmed investors and strengthened big banks, and were credited for avoiding another recession.

The Fed also pushed long term interest rates to historic lows. This led to harsh criticism of Bernanke from some 2012 Republican presidential contenders who claimed that the Fed was hurting dollar value and could cause inflation. And Bernanke’s unprecedented activism at Fed set a precedent for the central banking to respond quickly and forcefully to economic shocks.

When COVID-19 slammed the U.S. economy in early 2020, the Fed, under Chair Jerome Powell, quickly cut short-term interest rates back to zero and pumped money into the financial system. This aggressive intervention, along with massive government spending, quickly ended the downturn and triggered an economic recovery.

But the quick comeback also came at a cost: Inflation began rising rapidly last year and now is close to 40-year highs, forcing the Fed and other central banks to reverse course and raise rates to cool the economy. Monday’s press conference saw Bernanke express confidence in Jerome Powell, the current Fed Chair, and his former colleagues at central bank. However, he said that they had to face a “very difficult challenge” in trying to bring the economy into a so-called soft land. This means raising interest rates just enough for the economy to cool down and to tame inflation, without triggering a recession. Bernanke stated that he and his wife had turned their phones off last night and were only just learning about the Nobel when their daughter called.

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

Before that, economists cast blame on the Fed for not printing enough money to support the economy as it sank. Bernanke agreed, but he found that the lack of money was not the reason why the depression was so severe and lasted so long.

The problem was, he discovered, the collapse of the banking sector. Panicked savers pulled cash out of rickety banking institutions, which could not make the loans that helped the economy grow.

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

“Ben Bernanke’s 1983 paper was startlingly original and of enduring importance — not in explaining how the Great Depression started, but in explaining why it lasted so long,” said former Fed Vice Chair Alan Blinder, an economist at Princeton University. “That insight has affected economists’ thinking ever since.”

Diamond and Dybvig showed that banks play a crucial role in resolving a nettlesome financial problem: Savers want instant access to their money, but businesses need time to see their ventures generate profits before they can repay loans in full. In a 1983 paper, Diamond and Dybvig explored the banks’ key role as intermediary between savers and borrowers.

They also discovered that banks are vulnerable. If savers worry about their bank’s failure, they will withdraw their money, forcing the bank into borrowing money to cover withdrawals. Governments can act as a lender last resort to banks and insure deposits to stop bank runs.

The insight: Simon Johnson, an economist at Massachusetts Institute of Technology, said that if you could stop panicking, banks would be fine. He has written extensively about the financial crisis. This is a powerful idea that can help people think about financial stability. ”

Diamond also stated in a 1984 paper that banks play a critical role in assessing borrowers’ creditworthiness, making sure loans are repaid and going to worthy projects. The economics award was the culmination of a week’s worth of Nobel Prize announcements in medicine and physics, chemistry literature, and peace. They carry a cash award of 10 million Swedish kronor (nearly $900,000) and will be handed out on Dec. 10.

Unlike the other prizes, the economics award wasn’t established in Alfred Nobel’s will of 1895 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. Teresa Crawford, an AP video journalist from Chicago, contributed.

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