Research by Ben Bernanke, Douglas Diamond and Philip Dybvig was largely vindicated by the failure of the banks in 2008
global financial crisis struck 15 years ago, economists were forced to respond to criticism that they had, for decades, ignored the banking system. With its choices for this year’s Nobel prize, Sweden’s Royal Academy of Science honoured three economists who had, in fact, spent the previous decades examining banking instability.
In this account, Mr Bernanke focused on the role played by banks in providing credit. The uncertainties inherent to lending and borrowing mean that such decisions require “information-gathering services”. When banks failed in the 1930s, new entrants could not easily replace them. Unlike a grocer, a new bank cannot simply move into its predecessor’s premises and set up shop. Knowledge about borrowers is hard won.
Banks allow savers to pool their money, and for these pooled savings to be used to finance long-term investments. Crucially, savers may withdraw their cash without imperilling these investments . In exchange for the service, banks take a slice of returns.
There is an escape from this problem, however, which Messrs Diamond and Dybvig demonstrated by employing game theory. It is rational for depositors to run on a bank so long as they believe others will. But such a course of action becomes fruitless if they believe others will remain at home. A system of insuring deposits, such as the one instituted by the
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