By illuminating how things can go wrong even in economies as robust as America’s, Bernanke has inspired significant, lasting improvement in economic policymaking.
Dr. Ben S. Bernanke, former Chair of the U.S. Federal Reserve and longtime advisor on the George W. Bush Institute-SMU Economic Growth Initiative’s policy work, won the Nobel Memorial Prize in Economic Sciences today for groundbreaking research on the causes of financial crises and depressions.
Bernanke was honored along with economists Douglas W. Diamond and Philip H. Dybvig. The three economists “have significantly improved our understanding of the role of banks in the economy, particularly during financial crises,” according to the statement from the Royal Swedish Academy of Sciences. “An important finding in their research is why avoiding bank collapses is vital.”
Bernanke was honored for two key insights:
First, he explained how banking crises can give rise to crashes and depressions. Breaking from earlier economists who viewed such crises as a common result of economic downturns but not a prime cause, Bernanke showed that financial distress can raise the operating costs incurred by banks in providing credit intermediation, leading them to curtail lending. Contractions in the availability of credit can in turn force businesses to invest less and lay off staff, sparking a recession or worse.
Second, Bernanke used this framework to develop a new explanation for why the world fell into the Great Depression of the 1930s. Bernanke’s account built on work by Milton Friedman and other economists showing that one of the Depression’s chief triggers was a contraction of America’s money supply caused by Federal Reserve mistakes and dysfunction in the international monetary system. Bernanke added a crucial piece to the puzzle, showing that the Depression kept getting worse for two years even after the money supply stopped shrinking – and that the key driver for this decline was reduced lending by banks suffering from distress in their existing loan portfolios. Before Friedman and Bernanke, economists tended to blame the 1929 stock market crash or the Smoot-Hawley Tariff Act of 1930, each of which contributed, but which economists now do not believe could have caused the most severe peacetime economic catastrophe in history.
Diamond and Dybvig, with whom Bernanke shares this year’s Prize, developed complementary explanations for why financial institutions are inherently vulnerable to “runs” on the banking system – one of the shocks that can spark the kind of banking crisis studied by Bernanke. Because banks fulfill the vital functions of making long-term loans but giving depositors the right to access their money whenever they need it, the banking system typically has a maturity “mismatch” on its balance sheet. This can lead depositors to withdraw funds in times of stress and precipitate a banking crisis, Diamond and Dybvig showed.
President George W. Bush appointed Bernanke to chair the Federal Reserve only a year before the early stages of the global financial crisis of 2007-2009. Drawing on his deep knowledge of the 1930s, Bernanke and his colleagues deployed new monetary policy tools to stabilize America’s banking system, partnering with Treasury Secretary Hank Paulson to halt a downward spiral that otherwise might have plunged the world into a new Great Depression. While the Nobel Prize honors research contributions rather than policy accomplishments, history will undoubtedly remember Bernanke for his leadership in that momentous period as well as for his profoundly consequential academic career.
Bernanke’s 40-year-old insights into the causes of the Great Depression and other financial crises remain central to modern-day economics. By illuminating how things can go wrong even in economies as robust as America’s, Bernanke has inspired significant, lasting improvement in economic policymaking and made people’s economic lives more stable and secure in the United States and throughout the world.
The Bush Institute offers Bernanke our heartfelt congratulations and gratitude.