We celebrate the contributions of the three new Nobel laureates in economics.

Enrique Blasco Garma
Consejero Académico en Libertad y Progreso

The world is much better prepared to face financial crises like the one in 2008. But unexpected events continue to raise fears, especially if people lose confidence in the system

INFOBAE: The economic crisis of 1930, the largest on record, impacted all of humanity. It saw world trade contract by 66%, created despair and exacerbated mistrust between countries and people, smoothing out the rise of Hitler in Germany that culminated in World War II. In the US, GDP sank 36% in nominal values between 1929 and 1933. This disaster catapulted the novel proposal of John M. Keynes to world preeminence in economic thought. For other specialists, these theories aggravated the contraction and only served to delay the crisis. In Argentina, the upheaval gave rise to the 1930 coup d’état, further state intervention and decline.

My dear professor at the University of Chicago, Milton Friedman, opposed this view by explaining that the real cause of the crisis was the errors of the Federal Reserve System. In particular, the Fed’s refusal to authorize “banking holidays”, which habitually served to prevent cash withdrawals from entities. This refusal, in the midst of depositors’ panics, and a contraction of 33% in the amount of money available led to the suspension and bankruptcy of thousands of banks. The monumental “Monetary History of the United States 1867-1960”, written by Friedman with Anna Schwartz, details what happened.

Influential politicians underestimate the financial aspects, insisting on “looking productive”, and without realizing become the other side of the same coin. The function of banks is to acquire illiquid assets –of various characteristics– and sell liquid deposits. For this, bank deposits play a very relevant role, forming a competitive market that stabilizes the costs of varying individual consumption over time. However, they are vulnerable to panics among depositors, even those who would keep their accounts if they were not afraid of being defaulted. Consequently, value producing financing would be in danger if not secured. Such conditions vindicate the relevance of transparent regulations. For this purpose, the Federal Deposit Insurance Corporation FDIC, created in 1933, has been providing regulations and data that makes the system more transparent. Friedman also proposed expanding the geographic scope of each bank. He cited the advantage of Canadian banks, which operated throughout that country, which allowed them to cushion the variations in business between different regions. While US entities were constrained to very narrow geographic limits; since most could not extend outside the city and many could not even open branches. These investigations are linked to those of Oliver Williamson, also a Nobel Prize winner, who developed an understanding of the role of economic organizations in making information transparent so that assets are more liquid and attractive.

In 2022, the Royal Swedish Academy recognized the research of the three Nobel laureates in economics. Ben Bernanke of the Brookings Institution, Douglas Diamond of the University of Chicago and Philip Dybvig of the University of Washington (St Louis) revealed that the true cost of banking crises is the closure of entities and lost credits. This highlights the relevance of avoiding bank runs.

Bernanke, who presided over the Fed between 2006 and 2014, faced the financial crisis of 2008 through massive purchases of public bonds and mortgage bonds, reducing interest rates and organizing bailouts of the main US banks. These mechanisms were later replicated when the quarantines contracted the activities.

The three laureates laid the groundwork for modernizing the understanding of the need for banks, why they are vulnerable, and how to respond to them. At the time of its publication, bank failures were considered consequences of economic crises rather than the causes of the crises. Knowing that it revolutionized understanding and forms of response. The contributions of the three winners explain the vital role of banks in the economy and how regulations, such as deposit insurance and standardizing data on financed assets, make banks less vulnerable, understandings that modernized banking regulations should be a top priority at a time of greatest economic uncertainty.

According to Diamond, the world is much better prepared to face financial crises like the one in 2008. However, unexpected events continue to raise fears, especially if people lose confidence in the system. These investigations would lead to the banking sector being perceived as healthy and able to respond to monetary changes in a measured and transparent way. However, decisions like those of Bernanke, at the head of the Fed, are still questioned. He led massive purchases of debt and other assets by the Fed. Actions that some attribute to the sudden price spikes that are plaguing today’s economy.