Now that the 30 days are up, I’m posting my entire WSJ op/ed on the most recent winners of the Nobel Prize in economics, written the morning the prize was introduced.
An Economics Nobel for and by Central Bankers
The winners maintain views on coping with monetary crises that many fiscal economists discover unusual.
By David R. Henderson
Oct. 10, 2022 6:34 pm ET
The committee that awards the Nobel Prize in economics introduced Monday it has chosen three U.S. economists for the 2022 prize: former Federal Reserve Chairman Ben S. Bernanke, Douglas W. Diamond of the College of Chicago and Philip H. Dybvig of Washington College in St. Louis. The award is for “analysis on banks and monetary crises.” The committee praised the winners for doing work “of nice sensible significance in regulating monetary markets and coping with monetary crises.” Many fiscal economists would disagree.
A careless reader of Mr. Bernanke’s prize-winning work might need seen it as including a couple of particulars to Milton Friedman and Anna J. Schwartz’s 1963 guide, “A Financial Historical past of the US, 1867-1960.” The truth is, it was fairly completely different. “I wish to say to Milton and Anna: Concerning the Nice Despair. You’re proper, we did it. We’re very sorry. However because of you, we gained’t do it once more,” stated Mr. Bernanke, then a member of the Fed’s board of governors, at Friedman’s ninetieth party in 2002. Sadly, as Fed chairman, Mr. Bernanke, together with his fellow Fed governors, did do it once more.
The primary conclusion that Friedman and Schwartz reached of their evaluation of the Despair is that the Fed, by failing to behave because the lender of final resort, let the cash provide contract by 30% between 1929 and 1933. But, in explaining its selection for this yr’s award, the Nobel committee writes, “Previous to Bernanke’s [1983] research, the final notion was that the banking disaster was a consequence of a declining financial system, moderately than the reason for it.” That will in all probability shock even Mr. Bernanke, who, as famous, put nice weight on the Friedman/Schwartz perception.
The distinction between the Bernanke and Friedman/Schwartz views was that Mr. Bernanke thought offering extra liquidity throughout a disaster wasn’t sufficient; he emphasised the significance of salvaging specific monetary intermediaries, even when a few of them arguably ought to have gone bankrupt. Whereas his educational work on this concern was deep and spectacular, it sadly prompted him, as Fed chairman, to not give attention to liquidity throughout the monetary disaster. Many fiscal economists on the time, together with Jeffrey Hummel, then of San Jose State College, and Scott Sumner, a Bentley College economist who had studied beneath Friedman, acknowledged that the important thing was increasing the cash provide moderately than selecting particular companies to assist.
As Mr. Hummel identified in 2011, Mr. Bernanke didn’t increase the cash provide sufficient. Quantitative easing, which expanded the cash provide, bought all of the press. Much less mentioned have been two Bernanke initiatives that choked off the rise within the cash provide. One was the sale of Treasury securities, which faraway from the financial system a lot of the cash the Fed had injected in 2008 through the Bear Stearns bailout and the Time period Public sale Facility. Economists name this “sterilization.” The outcome was that within the yr ending August 2008, the financial base (foreign money plus financial institution reserves) had elevated by lower than $20 billion, or 2.24%. Had Mr. Bernanke merely elevated the cash provide considerably, as Alan Greenspan had achieved in response to the 1987 market crash, the 2007-09 recession would have been shorter and shallower. The second measure restraining liquidity was Mr. Bernanke’s 2008 option to pay curiosity on financial institution reserves, which prompted banks to take a seat on reserves moderately than lend them out.
As for Messrs. Diamond and Dybvig, their 1983 mannequin purports to provide a theoretical rationalization of how financial institution runs happen, however what it calls “banks” are like no banks we all know of. As Lawrence H. White of George Mason College factors out in his 1999 guide, “The Concept of Financial Establishments,” the mannequin imagines an financial system with a single financial institution that doesn’t make loans and doesn’t concern checking accounts. The explanation for financial institution runs, in keeping with the mannequin, is that buyers (not account holders, since there are none) get nervous and attempt to money of their investments. The Diamond/Dybvig mannequin makes use of this bank-run potential to justify deposit insurance coverage.
Mr. White factors out that there are methods to make precise banks “run-proof.” One is to make checking accounts extra like money-market funds. Whereas the Fed, mistakenly for my part, opposed “breaking the buck” throughout the monetary disaster, permitting cash market funds to be redeemed at 97 or 98 cents on the greenback would have stopped a run. One other option to stop runs is for banks to stipulate that depositors can’t entry their deposits till they mature. Yet one more, which occurred earlier than the Federal Reserve was based in 1913, is to droop convertibility of deposits into foreign money. That approach, individuals might nonetheless write checks, however the financial institution, if merely illiquid however not bancrupt, wouldn’t undergo a loss.
The Nobel Prize in economics is funded not by the Nobel Basis however by Sweden’s central financial institution. I don’t often suppose that issues, however on this case I’m wondering if it does. The 2022 award appears to be an affirmation by central bankers of the worth of central banking.
Mr. Henderson is a analysis fellow with Stanford College’s Hoover Establishment and editor of the Concise Encyclopedia of Economics.
