Nobel Prize committee member highlights ‘first principles’ approach by Bernanke, Diamond and Dybvig

A commitee member of the Nobel Prize in economics has highlighted the “first principles” approach by Ben Bernanke, Douglas Diamond and Philip Dybvig in analyzing systemic risk in the banking sector as a key strength of the economists’ work.

Speaking with Econ Job News, Chicago Booth Professor Per Strömberg said the three economists’ research was ahead of its time because it focused on responding to fundamental, unanswered questions that remain crucial even as the banking industry changes.

He said: “One of the reasons why this series was so important is that for the first time they tried to understand financial institutions from first principles. Why do these animals appear in the economy, and what use are they? That’s actually made the series way more applicable to financial markets because financial markets evolve over time.”

Strömberg added: “The banks that were dominating 50 years ago, or even 30 years – now we have shadow banks, this and that – but the theories are equally applicable to these new phenomena as well, and I think that’s the strength of using these theories. They can adapt to an evolving world.”

He spoke with this publication after the trio of economists on Oct. 10 were jointly awarded the 2022 prize for their body of work on banking and regulatory oversight, including three pieces of research published during the early 1980s.

Douglas Diamond and Philip Dybvig in their 1983 paper Bank runs, deposit insurance, and liquidity presented a theory that showed that valuable maturity transformation is inherently vulnerable.

Meanwhile, Diamond in a 1984 paper Financial Intermediation and Delegated Monitoring developed the theoretical insight that delegated monitoring allows savers to get access to safe, high returns.

Bernanke received the award for addressing questions of systemic banking stability through empirical research in his 1983 paper Nonmonetary effects of the financial crisis in the propagation of the Great Depression. This used historical evidence and data to explain the importance of banking credit channels in deepening the crash.

Speaking to this publication, Strömberg emphasized that the prize is focused on honoring economists whose work has had deep, practical implications for society at large.

He said: “There’s nothing more practical than a good theory … [w]e thnk a lot about that. This is not the prize for mathematical elegance, it’s a prize for contributions that we can argue have helped society and mankind.”

“I think this year’s prize is a very good example of that because the Diamond-Dybvig theory and the Diamond paper have actually proven to be extremely practical to understand the world around us.”

Strömberg is Visiting Professor of Finance at Chicago Booth School of Business and Centennial Professor of Finance and Private Equity at the Stockholm School of Economics. He is a member of the award committee for the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2022.