Ben Bernanke, Philip Dybvig and Douglas Diamond’s work explained how finance greases the wheels of capitalism – and why the system is inherently unstable.
Credit: The Brookings Institution, Washington University, University of Chicago Booth School of Business
The research of the three laureates has both helped to explain why banks exist in the form they do, and why they have fragilities that can be devastating to the economy, as shown both in the Wall Street Crash of 1929 and the Great Depression that followed, and the global financial crisis of 2008.
The model also showed the weakness of this system. If enough savers are hit by some external ‘liquidity shock’ — a societal event that makes them want to withdraw their money — this can lead to panic and a vicious circle, in which ever more of them withdraw in fear that the bank will run out of funds. This is an inherent instability that can lead to bank collapse, although safeguards such as deposit insurance can reduce the risk.
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