Lesson from the 2022 Nobel laureates on the financial crisis – Academia


Fajar Hidayat (Jakarta Post)

PRIME

Jakarta ●
Wed, October 26, 2022

Economics is sometimes satirized as “nothing more than complicated common sense”. Yet common sense scientifically developed into a model or theory has often been able to explain and solve complicated problems.

In this regard, the awarding of the 2022 Nobel Prize in Economics to Douglas Diamond, Philip Dybvig and Ben Bernanke testifies to the importance of these models and theories. Their work since the early 1980s has improved the lack of understanding of how banks work and how when they fail it causes financial crisis.

Diamond and Dybvig (1983) modeled how banks functioned as custodians of savers’ funds and channeled them as loans to borrowers when the funds could not be withdrawn instantly. Under normal circumstances, such liquidity transformations have worked well for generating wealth in society. However, this led to bank runs if savers panicked and withdrew their funds simultaneously, thus causing bank failures due to inadequate liquidity. The model suggested deposit insurance to protect savers against bank failures.

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