“Their findings have improved the way society handles financial crises,” the committee said, crediting the academics for showing policymakers that preventing banks from failing is essential.
Bernanke, who led the Fed through the 2008 financial crisis, has been recognized for his groundbreaking 1983 analysis of the Great Depression. The committee said its research showed how bank runs turned an ordinary 1930s recession into the worst global economic crisis in history.
Bernanke demonstrated that bank failures – rather than resulting from the recession – 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 into productive investments, the committee said.
During the 2008 crisis, Bernanke steered the Fed toward extensive use of central bank powers, driving interest rates to near zero and accumulating assets worth a then-record $4 trillion in the purpose of stimulating economic activity.
The former Fed chief, now affiliated with the Brookings Institution, said he learned of the price this morning during a phone call from his daughter.
“It was completely unexpected,” he told reporters. “My wife and I turned 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 let us know that it had happened.
Diamond and Dybvig were honored for their pioneering theoretical work, also in 1983, which explained the role of banks in connecting savers and borrowers in a mutually beneficial relationship.
The two men showed how banks resolve an inherent conflict between those who have excess funds at any given time and those who need more money than they have. Savers want immediate access to their money in case of unexpected expenses, while borrowers want reassurance that they won’t be forced to repay their loans prematurely, the committee said.
By acting as an intermediary, banks pool the savings of many people, 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 the essential function of banks makes them vulnerable to rumors of potential collapse. If savers fear that a bank is about to fail, withdrawals can snowball into a destabilizing and self-fulfilling “race” on the bank. This disastrous outcome can be avoided, as is the case in the United States, by requiring the government to provide deposit insurance that protects savers against such losses and by having the central bank operate as a lender of last resort.
Diamond was also recognized for his 1984 work showing that banks play a vital role in gathering valuable information about borrowers, assessing their creditworthiness and ensuring that loans are used for healthy businesses.
The awards committee awoke Diamond with the news of his Nobel Prize and put him in touch with the ceremony.
“It was a surprise,” Diamond said over the phone. “I slept very well.”
The three economists will share the prize money of 10 million Swedish crowns, or approximately $885,810.
The award comes as world financial leaders prepare for this week’s annual meeting of the International Monetary Fund and World Bank in Washington, as the global economy slows amid high inflation.
Although current conditions bear little resemblance to the 2008 crisis he handled at the Fed, Bernanke said financial risks can emerge without warning.
“Even if financial problems don’t start an episode, over time, if the episode makes financial conditions worse, they can compound the problem and intensify it,” he said. “So I think that’s really something that we need to pay close attention to.”
Speaking by phone, Diamond told reporters in Stockholm that the financial system is better equipped today than in 2008, and he predicted that central banks will be successful in controlling inflation.
He also said that efforts to design an invulnerable financial system would interfere with its primary function of creating liquid or readily available assets from illiquid assets.
“It’s possible, but not necessarily desirable” to seek such perfection, he says.
The award ceremony was broadcast live on the Nobel institution’s website.
Prior to Monday’s announcement, a total of 89 people had received the prize, officially known 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, Berkeley, who received half the prize, and two other economists, Joshua Angrist of the Massachusetts Institute of Technology and Guido Imbens of the University of Stanford, for their work drawing conclusions by observing the cause and effect of real-world economic actions.