MTA (Hungarian Academy of Sciences) conference: the work of Nobel laureates is still relevant today

On 10 October 2022, the Nobel Memorial Prize in Economics was awarded to Ben Bernanke, former chairman of the FED and a member of the Brookings Institution, Douglas Diamond of the University of Chicago, and Philip H. Dybvig, professor of economics at Washington University in St. Louis. Their achievements are still relevant today, and the issues and problems they raise are being further explored in countless places around the world. The Committee has a tradition of reviewing the work of Nobel Laureate economists – these were the words of Dóra Győrffy, President of KTB, in her introduction of the conference. Bernanke, as chairman of the Federal Reserve, has already applied the results of his 1983 paper (in which he examined the 1929-30 world crisis) and the Diamond-Dybvig model in practice. It was precisely this research that helped prevent the 2008 crisis from causing even greater damage. 

In her presentation “If the banking system dies, the economy dies too”, Júlia Király (IBS) said that the three Nobel Prize winners published their famous papers as early as 1983, but as a contemporary it is sometimes difficult to recognise whose paper will later become a guiding theory. But an important achievement of the three researchers is that they have shown that the banking system is highly vulnerable. In fact, there is a fundamental contradiction between depositors and creditors: depositors want a high-yielding investment that they can access whenever they need it, while those seeking a loan want a long-term loan. Obviously, the banks are not aware in advance when the depositor will need the money. Naturally, a big advantage for the bank is that it can monitor borrowers: it can assess how risky it is to lend to a particular borrowing company – depositors (i.e. households) are unable to obtain such information. Diamond and Dybvig argued that deposit insurance was an effective way of avoiding bank failures: it would reassure depositors and avoid bank failures. Júlia Király stressed: Bernanke, as chairman of the Federal Reserve, had a major role to play in preventing the crisis that started in 2008 from becoming an even more prolonged crisis. 

András Mikolasek (Magnetbank, Corvinus) pointed out that in the mid-1980s banks ‘didn’t matter’, so to speak, and were not really talked about. The main merit of the three Nobel laureates is precisely that they have highlighted that there are many small investments and many feasible investments that the bank can finance indirectly, because it is between the two parties – the borrower and the investor. If the financial institution behaves properly, the bank undertakes that depositors will be able to withdraw their money continuously, with interest. “If the bank diversifies the portfolio properly, the damage will not be borne by the depositor,” he said. As Mikolasek puts it, Diamond and Dybvig’s valuable point is that bank fragility is not caused by the irresponsibility of bankers, but that is simply the nature of banks. 

János Hubert Kiss (MTA Research Centre for Economic and Regional Studies) talked about bank panics. As he said, even with well functioning banks, depositors may want access to their money all at once. The most important issue here is what influences the depositor’s behaviour. To what extent does the depositor know if the bank is working well? Generally this is not common knowledge. At poorer banks, it is more likely that customers will storm the bank and try to withdraw their money, but unjustified bank attacks also occur. Depositors’ behaviour is also tested under laboratory conditions. Even so, there are rather few good databases on what causes a bank panic: the customer may have known something about the bank’s fundamental problem, or simply needed their money, or seen others trying to withdraw their money from a particular bank and simply followed them – the latter case being a bank panic. It is also investigated who tends to take their money out immediately in such situations: those who are educated, experienced, wealthy or the opposite. Another interesting question, and currently a research topic, is who influences the depositors’ decision. Studies so far show that so-called social networks matter in this situation – what do neighbours, family members, acquaintances do? Who sees whose behaviour? Of course, online banking also complicates this issue, as anyone can transfer their savings to another financial institution while sitting at home. For sure, the size of the deposit is an important factor, as there is no deposit insurance above a certain amount, for example. An important example of this was the financial upheaval that hit the US economy in 1907, which was felt most acutely in New York, where the stock market fell by 50% relative to the previous year. At that time, the institutional system responsible for financial stability did not yet exist in the US. Depositors withdrew their money from banks in a mass. Banker J.P. Morgan and his circle tried to stop the crisis, e.g., by his men visited all the priests, ministers and rabbis in the city and asking them to urge their followers not to withdraw their money from the banks. The rescue operation was a success because the crisis subsided in a few weeks and life returned to normal. 

The presentation was followed by a panel discussion where participants shared their views on financial crises, monetary policy and banks. Former central bank governor György Surányi emphasised that if fiscal, monetary and income policies are not moving in the same direction in a country, “you can close up the shop”. 

Katalin Török