Former US Federal Reserve chair Ben Bernanke and fellow academics Douglas Diamond and Philip Dybvig have been awarded the 2022 Nobel prize for economic sciences. Their work delved into the role of banks and their vulnerability to crises of confidence in ways that informed policy. Banks serve as intermediaries between savers and borrowers, but the wonder of fractional-reserve banking that lets depositors withdraw money on demand while loans extend for years also has a core fragility: If panic results in bank runs, as in the Great Depression, then shocks can multiply and worsen the economic impact, deepening and prolonging the pain. Bernanke once put out a mea culpa on the Fed’s behalf for failing to intervene in the 1930s. Pre-emptive support for shaky banks in case of a liquidity crisis judged to be contagious, as the US provided during the Great Recession, has been considered a central bank must-do for many years now. The award reflects the consolidation of conventional wisdom in favour of backing systemically vital banks that are “too big to fail”. What we should study in more depth, though, is what this does to incentives and the challenge of withdrawing crisis support.
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