NOBEL FOR CRISIS RESEARCH

 The 2022 Nobel prize in Economic Sciences is shared by American trio- Ben S Bernanke,  ex chair of Federal Reserves (1stFebruary2006 toJanuary 31 2014) and Senior Fellow Brookings Institute, Douglas W. Diamond,Professor Chicago University and Philip H.Dybvig, Professor, Washington University for their rigorous research on bank collapses and their impact on broader  economy and specifically how to avoid bank collapse . Their analysis is largely based on the experience of great depression of 1930s. Financial crisis and depressions are kind of worst things that can happen in the economy. These things can repeat again and we need to have an understanding of the mechanism behind those and what to do about it is well articulated by this year's three Nobel laureates.

Firstly former US Federal Reserve chair person and researcher Ben Bernanke focused his academic expertise in analysing the intricacies of the great depression of 1930s. Bernanke's work  of 1983 observed that  because of the Great Depression between  January 1930 and March 1933 the US industrial production plummeted by 46%  and unemployment rose to 25 % .The crisis spread like wild fire across the world resulting in deep economic downturn of the economies like Great Britain (unemployment 25% ) Germany and Austria (33%unemployment) and Chile similarly (33%).Every where  banks had  collapsed,people were forced to leave their work place and widespread starvation persisted even in relatively rich countries. World economy slowly began to recover only towards the middle of the decade.Great depression revealed the dangers of bank runs as evidenced by panicked people withdrawing their savings leading to bank collapses and widespread economic devastations. Until Bernanke's paper, bank failures were seen as a consequence of financial crisis. But his 1983 paper provided exactly opposite finding that bank failures were the " cause " financial crisis. Applying a combination of historical sources and statistical methods his analysis showed which factors were responsible to drop in the GDP.He found that the factors that were directly linked to failing banks accounted for the lions share of the downturn. Bernanke zeroed in on bank runs as the key reason responsible for a small recession spiraling greatest economic crisis in modern history. Bank runs happen when people who have deposited money in a bank become worried about the bank's survival and consequently rush to withdraw their savings. If more people do it simultaneously then bank's reserves cannot cover all withdrawal and obviously it lead into bankruptcy. Due to bank runs the recession of 1929 gradually turned into a full-fledged depression.According to Bernanke economy did not recover until the state implemented drastic measures to prevent further bank panics.

Douglas W Diamond and Philip H.Dybvig's research analysed why banks fail and the role banks can play in smoothening the potential conflict between savers waiting access to their money and the economy's vital need to put savings into investment. At the surface level it is simple that banks mobilise savings from households for making investments by borrowers. But there is fundamental conflict between savers and borrowers. While depositors want instant access to their money when need arises borrowers need to know that banks won't suddenly demand their money back. Diamond and Dybvig model solves this conflict through the process called " maturity transformation ",wherein banks serve as intermediaries between depositors and borrowers and create liquidity. While depositors accounts are short maturity liabilities since depositors can withdraw their money at any time ,long term loans for the borrowers are long maturity assets for the banks and they may not be repaid for many years. But as long as depositors are unlikely to withdraw their money all the same time banks can transform short maturity liabilities into long term maturity assets in the form of loans to borrowers. Rumours that banks being unable to cope with withdrawal can cause banks to become bankrupt if enough depositors rush to withdraw their money. To protect banks from such vulnerabilities Diamond and Dybvig proposed several solutions including Governments backed depositors insurance .Deposit insurance  can prevent a bank run before it happens- If depositors know that their money is guaranteed by the Government and they need not rush to withdraw their money even if there are rumours of a bank run.It is to be noted that USA was the first country to adopt Bank insurance in 1933, India followed suit only in 1962.The Diamond Dybvig model is central to understanding how banks function in the economy and how runs on banks should be understood and how they can be prevented.It has been observed that Raguram Rajan had written many with Douglas Diamond and Rajan's 12 papers were reviewed on banks and financial crisis by the committee but his name was not considered for the prize.

While John Maynard Keynes advocated fiscal stimulus to counter depression Nobel laureate Milton Friedman advocated that monetary factors are responsible to revive the economy. Ben Bernanke, Douglas W Diamond and Philip H.Dybvig through their research which largely focused on the centrality of finances to economic crises and on how governments can and should intervene to prevent such financial crises. Bernanke was not only debating hypotheticals with his students but as Federal Reserves chair and policy maker made critical decisions under intense pressure to tackle global recession and financial crisis of 2008, keeping credit creation process intact and bailing out large US banks.However while the credit creation process is performed well by banks, performance is generally poor in tackling either non Performing loans or meeting capital adequacy requirements.In short while multilateral institutions like IMF are warning that "the worst is yet to come " the theme selected for this year's Nobel prize and creative debates on that assumes  great significance.