Banks and Crises: Interpretation of the 2022 Nobel Prize in Economics

Chen Yongwei/Wen

Among the six prizes called "Nobel Prize", the Economics Prize was not established according to Nobel's own will, but was created in 1969 by the Bank of Sweden (Note: Swedbank is the central bank of Sweden, but it also plays the role of a central bank and also does the business of a commercial bank) in honor of Nobel, and its full name is "Bank of Sweden in Memory of Alfred Nobel Prize in Economics". The prize money awarded to the laureates does not come from Nobel's legacy, but is sponsored by Swedbank. Since its inception, the prize has been awarded more than 50 times, rewarding more than 80 scholars with the most outstanding contributions in various fields of economics. Interestingly, however, the bank's prize had never been awarded to anyone who specialized in banking issues. This year, this "convention" was finally broken.

At noon on October 10, local time, the Royal Swedish Academy of Sciences announced that the 2022 Nobel Prize in Economics will be awarded to three American economists: BenBernanke, an economist at the Brookings Institution, Douglas Dia-mond, a professor at the University of Chicago, and Philip Dybvig, a professor at the University of Washington, for their outstanding contributions to the field of banking and financial crisis research.

If you know anything about the field of banking economics, you will be familiar with these three winners: Bernanke was the chairman of the Federal Reserve, and when he was in office, banks around the world would care about his decision to raise or cut interest rates; Diamond and Davidg are not as well known to the public as Bernanke, but their research on bank runs is a cornerstone of the field. It is only fitting that this award should be given to these three for the study of banking issues.

So, from an economic point of view, what role do banks play in the economy? How do these three Nobel laureates discuss the role and influence of banks? What are some interesting experiences in their respective research careers? Let's talk about these questions one by one.

A Brief History of Banking and Banking Theory

Banks are the most common type of financial institutions in our daily life, and their main job is to undertake the function of credit intermediary through deposits, loans, foreign exchange and other businesses. Etymologically, the word "bank" comes from the Italian banco, which originally meant bench. Benches were an important business tool for money changers in those days, and they sat on the benches to serve customers. Later, the word banco was introduced into English, the spelling was adjusted to bank, and the meaning of the word was changed to the cabinet where money was deposited, and then there was the meaning of the bank that everyone is familiar with now.

From the etymological archaeology of the above paragraph, it is not difficult to see that most of the banks should come from Italy. And that's exactly what happened. According to records, the earliest banks in history were founded in the 12th century by the Piccolomini family in the Italian city of Siena. In Italy at that time, the Piccolomini family was no less prominent than the later Medici family. It is not surprising that such a family integrates several types of financial business in its hands to create a bank in the modern sense. At its peak, Banco Piccolomini had a presence not only in Italy, but also in England and France. Unfortunately, this oldest bank has not survived. In 1472, another new bank called the Bank of Siena appeared. Its winning formula was to attract the pope to the partnership. With the great appeal of this shareholder, Banco de Siena won the competition with Banco Piccolomini. In the end, the Bank of Piccolomini, which had flourished for 300 years, had to come to an end, and the Bank of Siena survived more than 500 years of vicissitudes.

Of course, even if the Bank of Piccolomini had not collapsed, it would have been less than 900 years from today, which is actually a very short period of time from the perspective of financial history. You know, as early as the ancient Babylonian period, financial activities such as lending have appeared. In this sense, banking is indeed a "new" invention in the financial industry.

From the late sixteenth century, the "new" invention of banking began to be favored by financial practitioners, many of whom reformed the old-fashioned financial services institutions and started banking business. During this period, European commercial centers such as Venice, Milan, Amsterdam, Nuremberg and Hamburg opened banks, and many of them continue to operate to the present. In 1694, in order to raise funds for the war, the British government publicly offered shares to the public and established the Bank of England, which broke the tradition that only individuals or families could establish banks and set a precedent for joint-stock banks. This made it easier for later people to start a bank and do business. Subsequently, the position of banks in the financial industry and indeed in the economy as a whole rose rapidly. Today, banks are the most critical financial sector – perhaps a little lower in a country with more developed equity financing like the United States, and in more parts of the world, banks are arguably the hub of the entire financial system.

Because the bank is so important, it has entered the field of view of economists from a very early stage. In general, in the period of classical economics, economists have recognized the importance of banks in acting as intermediaries between the supply and demand of money.

In the past, although lending relationships also existed, the connection between the demand side of funds and the supply side of funds could mostly only occur on a small scale, such as relatives and friends. Even with the blessing of old financial institutions such as money houses, the expansion of this scope is still limited. After the emergence of banks, it can absorb funds in people's hands on a large scale, and then release them to those who need funds, so that they can achieve the matching of supply and demand in a large range of time and space, so that funds can be allocated and used more efficiently.

Adam Smith summed this up well in The Wealth of Nations. He said: "Prudent banking activities can enhance a country's industry, but the way to improve it is not to increase a country's capital, but to make most of the capital that is not used useful, and most of the capital that is not profitable is profitable." The merchant had to store up much-needed stagnant wealth, which was nothing for the merchant himself or his country. Prudent banking activities can turn this dead asset into living assets, in other words, into the materials, tools and food necessary for work, for the benefit of both the country and the country. ”

Compared with classical economists such as Smith, Marx's view of the function of banks is more profound. He said in the third volume of Capital: "The modern banking system, on the one hand, concentrates all idle monetary reserves and puts them into the money market, thereby depriving usury of the monopoly of usury capital, and on the other hand, it establishes credit money, thereby limiting the monopoly of precious metals themselves." ”

It is easy to see that in Marx's view, the role of banks in the economy actually has two aspects. The first of these is Smith's reference to pooling funds. Of course, Marx was more acutely aware of the consequences of this pooling than Smith, namely the breaking of the monopoly of usury capital. As mentioned earlier, before the creation of banks, people could only borrow on a small scale when they needed funds, and in this local market, the holders of funds clearly had a monopoly and could therefore claim high interest rates from them. However, with the bank, people can borrow money from countless people everywhere through the intermediary of the bank, and the monopoly of usury capital is broken, and the interest rate will of course fall accordingly. If you read Sidney Homer's History of Interest Rates, you will see that after the rise of banks, interest rates in the market did fall dramatically.

Marx's insight that banks can create credit money is even more insightful. The so-called creation of credit money means that after the bank absorbs deposits, it can save and allocate part of the funds for emergency needs, and release the remaining funds as loans. In this way, the amount of money circulating in the market exceeded the original amount of money in the market, and the monopoly of the currency itself (which was a precious metal at the time) was broken. As credit is created, it becomes easier for people to get money from the market. In this way, the circulation of goods in the market will be faster, the circulation of capital will be smoother, and the efficiency of the operation of the entire economy will be improved. However, at the same time, the creation of credit will also bring more instability to the economy, which means that changes in the bank's strategy will have a great impact on the amount of money in circulation in the market, and the bank's own strategy is very vulnerable to the judgment of its operators on the market.

Later, Schumpeter incorporated this view into his analysis system and proposed his own business cycle theory. He noted that when the economy starts to boom, banks tend to create more credit; And as banks change their attitude towards the future, credit could be tightened, leading to currency tensions in the market. It is this kind of convergence that causes a lot of disruption to the economy, which brings about cycles. In Hayek's business cycle theory, which was about the same time as Schumpeter, we can see similar statements - the difference is that Hayek packaged these ideas with Wicksell's theory of natural interest rates and Austria's favorite theory of production structure, but in this theory, the role of the bank is actually as Schumpeter said, and the origin of these ideas can be more or less traced back to Marx (Note: In fact, Hayek himself was familiar with Capital, It is even a must-read literature for students. This, he mentioned in the book "Price and Production").

In the '60s, Stanford University's John W. J.G. Gurly and Edward Gurly In his book Moneyina Theory of Finance, E.S. Shaw proposed a third theory on the role of banks, which is different from the aforementioned "financial intermediation" and "credit creation theory." In their view, the most important value of the existence of a bank is the conversion of direct securities into indirect securities.

The direct securities mentioned here refer to public bonds, treasury bills, bonds, stocks, mortgage contracts, loan contracts and other forms of bills issued or signed by non-financial institutions, such as governments, industrial and commercial enterprises and even individuals. Indirect securities refer to negotiable certificates of deposit, life insurance policies, financial bonds, etc. issued by financial institutions. In reality, each of us can issue "securities", for example, Zhang San bought goods worth 100 yuan for Li Si, Zhang San's money is in the bank, there is no cash, so he can send an IOU of 100 yuan to Li Si. If both men are trustworthy, then the security is usable between them and its value is $100. However, if it goes beyond this range, it may not work well. For example, if Li Si owes Wang Wu 100 yuan and wants to use this IOU to settle the debt, then Wang Wu is likely to not recognize this IOU. But it's different if you don't use an IOU, but a bank check. Essentially, a bank's check is a security issued based on bank debt, which marks that the bank owes the holder of that check a sum of money. After Zhang San gave Li Si a check of 100 yuan, he easily transferred it to Wang Wu or others. This example shows that direct securities issued by individuals or private enterprises are far less effective in use than indirect securities issued by banks. Therefore, when people deposit funds in banks, the direct securities that would have been issued by them can become indirect securities issued by banks, and their circulation scope and recognition will increase significantly.

These are the more popular banking theories before the winners of this Nobel Prize. But in the '70s, these traditional theories were severely challenged. At that time, there was a popular "decline in the status of banks", believing that with the reduction of information costs, the supply side and the demand side of funds could find each other more and more easily. In this case, people can completely leave the bank and have a "no middleman to make the difference". Now that the bank's role as an intermediary has been abolished, the subsequent creation of credit and the transformation of direct securities into indirect securities naturally cease to exist. In the face of such theoretical doubts, how should banks justify themselves and explain the meaning of their existence? Now, it's Diamond's and David's turn to play.

Diamond and David, and their research

"Two wears" its people

Before introducing Diamond and Daviger's theory, it is necessary to give some introduction to their lives and experiences.

Diamond was born in 1953. He attended Brown University as an undergraduate, where he briefly served as a program assistant at the University of Chicago as Gary Becker. He received his bachelor's degree in 1975 and then went on to study economics at Yale University, earning a master's degree (M.A.), an M.Phil in 1977, and a Ph.D. in 1980. After graduating, he has been engaged in teaching and research at the University of Chicago. He is now the Merton H. Miller Distinguished Service Professor of Fi-nance at the university's Booth School of Business. Diamond's research focuses on financial intermediation, liquidity, financial crises, and financial regulation. He has made many pioneering contributions in these areas. These achievements have earned it many honors, including the 2012 American Finance Association's Morgan Stanley Award and the 2018 Onassis Finance Award.

Daviger was born in 1955. During his undergraduate studies, he attended Indiana University with a major in physics and mathematics, and received his bachelor's degree in 1976. He then went on to Yale University, where he received his M.Phil degree in 1978 and his Ph.D. in finance in 1979, and his doctoral thesis was supervised by Professor Stephen A. Ross, the founder of the famous "arbitrage pricing" theory (Note: It is worth mentioning here that Ross is definitely a "Nobel Prize jewel"). His theories are groundbreaking in the financial community and have directly inspired Nobel laureates including Merton, who unfortunately died in 2017 and ultimately failed to win the Nobel Prize. As his proud protégé, Daviger once wrote an introductory essay about him, which sums up his academic achievements well). After graduation, Davidger worked at Princeton University, Yale University, and Washington University (St. Louis). It is worth mentioning that since 2008, Daviger has also accepted the invitation of Southwestern University of Finance and Economics in mainland China as a professor and dean of the Institute of Financial Research until 2021. In other words, Daviger almost became the first economist to win a Nobel Prize while serving at a Chinese university.

Whether it is Diamond or David, their academic research has a relatively obvious stage focus. In the early eighties, the two scholars made pioneering contributions to microbanking economics, especially bankruns. Since then, their research interests have shifted, with Diamond turning his research focus to corporate finance, trying to revisit some of his early investigations from a corporate perspective, while Daviger has focused his research on the field of asset pricing pioneered by his mentor Ross. After the mid-nineties, Diamond turned his research back to banks by starting with liquidity, and into the new century, focusing on the role of banks in financial crises. Daviger has not returned to the study of banks, but continues to work in the field of asset pricing. In addition, after accepting an offer from Southwest University of Finance, he also led the students there to do a lot of research on China's economy.

Since the Nobel Prize is mainly to reward the research of several scholars on banking, in the following introduction, we will use Diamond's research as the main line of introduction. Since Daviger's research on banking was largely a collaboration with Diamond, this narrative does not undermine the integrity of the presentation.

What exactly is the role of banks?

After finishing the above character introduction, we pull the story back to the main line. As mentioned earlier, in the 70s, voices questioning the role of banks began to rise. So, in the face of such doubts, how should the bank be justified? One possible idea is to introduce the then-nascent information economics to justify the need for banks from an information perspective. In this regard, the first work was the 1976 paper "Information Asymmetries, Financial Structure, and Financial Intermedia-tion" by Hayne E. Le and David H. Pyle. The paper, which is just over a dozen pages, makes an important point: that financial intermediation, including banks, is created to deal with information asymmetries. This idea, as soon as it was proposed, shifted the discussion of the role of banks from acting as intermediaries and creating credit to dealing with uncertainty, and the contribution of Diamond and others developed along this line.

Diamond's discussion of the role of banks is centered on two papers. The first was his seminal 1983 paper with Daviger, "BankRuns, DepositInsur-ance, and Liquidity," a seminal paper on the issue of runs. The second is his monograph "Fi-nancial Intermediationand DelegatedMonitoring."

In a 1983 paper, Diamond and Davidger argued that the role of banks was primarily to provide liquidity insurance to investors under conditions of information asymmetry. Specifically, they built a two-phase model that tells the story that in reality, investment projects require long-term commitments, and the costs incurred are irrecoverable until the project is completed. However, in the process of the project, investors may face liquidity shocks at any time, and once such a situation occurs, they will have to terminate the project, causing a lot of losses. In general, for risk events, people can diversify and eliminate the risk by purchasing insurance. However, due to the serious information asymmetry of events such as investment, it is difficult for insurance providers to know the personal information of investors, and it is difficult to infer the corresponding probability through large samples, so it is impossible to provide insurance for such behavior. The existence of financial intermediaries such as banks precisely plays the role of providing liquidity insurance for investors. When investors face liquidity shocks, bank loans can help them tide over difficulties and better realize intertemporal resource allocation. And this role is reflected at the macro level, which can promote the improvement of the efficiency of economic operation.

In a paper he wrote independently in 1984, Diamond discussed the role of banks from another angle, proposing the theory of "delegatedMonitoring." He pointed out that due to the existence of information asymmetry, borrowers will have moral hazard problems after the fact. Once borrowers have borrowed money, they can use it to do whatever they want, and the ability of financial contracts to bind them is very low. Obviously, this will increase financial risk in the market. With the introduction of financial intermediaries, they can act as an agent between depositors and lenders to monitor the implementation of contracts. Diamond used the model to show that this can lead to significant cost savings compared to having depositors directly supervise borrowers.

Through the above two papers, Diamond responded well to the question of "the decline of the role of banks" from the perspective of information, thus justifying the name of banks.

How can bank runs be prevented?

Although the emergence of banks can provide investors with effective liquidity insurance, banks themselves are also fragile and full of risks. We know that while there is a lot of money in the bank, in essence, it is not the bank's own. If, at some point, depositors go to the bank to pay back, and the bank does not pay the money, then it will also fall into liquidity difficulties. In finance, this phenomenon is called a "run". Because banks are profit-seeking in nature, after absorbing deposits, they will release most of the funds as loans, leaving only a small amount of reserves to cope with some sporadic payments. Therefore, once a large-scale run occurs, if there is no external intervention, the default or even failure of the bank is almost inevitable.

So, what is the mechanism of the run and how to prevent it? In the 1983 paper, Diamond and Davidger analyzed this in detail. In their view, the occurrence of a run is actually a manifestation of multiple equilibrium in the economy. Specifically, whether each depositor chooses to go to the bank to withdraw his or her deposits depends on their confidence in the bank, and this confidence is determined by the behavior of those around him. If he finds that no one rushes to withdraw money, it means that the bank is safe, so there is no need to withdraw it himself; But if one day, he finds that everyone rushes to the bank to withdraw money, then it means that there is a problem with the bank, and he must also rush to withdraw money. So when panic arises, it creates a process of "self-fulfilling" – everyone is afraid that something will happen to the bank, and the bank will really have a problem.

Since the problem of runs stems mainly from people's confidence in banks, to prevent this from happening, it is necessary to break the transmission mechanism of this panic. To this end, Diamond and Davidger suggest that the state provide deposit insurance to banks, which can boost depositor confidence and allow banks to better help investors withstand risks.

The two-phase analytical framework proposed in Diamond and Davidger's paper is so famous in the analysis of bank runs that it is often referred to in the literature as the Diamond-Dyvig model, or the D-D model. Much of the subsequent discussion of bank runs was based on this model.

Liquidity issues

Since the mid-nineties, Diamond's research has focused on the discussion of liquidity problems, and has used this as an entry point to re-explore the problem of banking. He provided a lot of valuable discussions in this area. Among them, his papers with Rajan, "ATheory of Bank Capital" and "Liquidity Risk, Liquidity Creation and Financial Fragility: ATheory of Banking," are the most important. In both papers, they make a very interesting point, "illiquidity is an inherent property of assets".

How to understand this view? We can consider a situation where in reality, different people with the same amount of money, or a set of equipment, can do completely different things. When a genius entrepreneur owns an asset, he can use it to buy equipment, make products, and sell them for a lot of money, but if he changes to another person, he may not be able to do anything. But if at some point, the entrepreneur is unable to produce because of the liquidity dilemma, and the equipment he buys has been invested in a special business, becoming a so-called relationship-specific asset that cannot be converted into an equivalent amount of funds, so that even if the entrepreneur tries to sell a part of the asset to obtain liquidity, it is not available. In other words, once each asset is formed, it is a "Rela-tionshipSpecificInvestment" stamped with its users, and its liquidity properties disappear.

So how can it help ease liquidity in the economy? This requires the help of financial intermediaries such as banks. In Diamond and Rajan's view, although many investment projects lack money, there are not many rich donors in the market. It's just that they don't dare to lend money to project operators because they have difficulty accessing project information on the market. And if no one invests in the project, the lack of funds in the market will lead to fewer projects operating in the market, and the financial owner will be more reluctant to lend money. Under this vicious circle, the problem of liquidity shortage has emerged. At this time, if there are financial intermediaries involved, this endless circle can be broken to a considerable extent and the liquidity in the market can be improved.

Financial crisis issues

As the new century began, Diamond's research interests began to turn to the analysis of financial crises. In this area, he has published many papers with collaborators such as Rajan.

One of the more representative papers is Banks, Short-term Debt and Financial Crisis: Theory, Policy Implications, and Appli-cations, published in 2001. In this article, they analyze the Asian financial crisis of 1998. At the time, it was widely believed that the key to the Asian financial crisis was the lack of limits on short-term debt. Diamond believes that short-term debt is very important in alleviating the liquidity problems in Asian markets, and is not the main cause of the financial crisis. The financial crisis was mainly caused by the inefficiency of investment projects and the lack of supervision.

Two other important papers are "The Credit Crisis: Conjectures about Causes and Countermeasures" in 2009 and "Panic Selling, Illiquidity, and Credit Freeze" in 2011. In both papers, Diamond and Rajan provide an in-depth analysis of the 2008 financial crisis. They point out that after the high-tech bubble burst at the beginning of the new century, real estate prices rose, driven by the Fed's monetary policy. This has enabled the US financial industry to expand its credit scope through asset securitization, and to package and divide risks through securitization. On the one hand, this leads to the accumulation of credit risk, and on the other hand, it also makes asset pricing more difficult. When real estate prices rise, the problem is not prominent, but when real estate prices plummet, the hidden risks are exposed. In this process, improper incentives at the top of the bank and the capital structure of the bank will expand this risk.

Diamond and Rajan point out that panic selling, and the fear of panic selling, are important reasons for amplifying the crisis during the financial crisis. This fearful sell-off can cause asset values to plummet, and banks in the market will fail one domino after another. Once the crisis has reached this point, it cannot be self-help by self-adjustment within the financial system alone. At this time, it was time to let financial "firefighters" like Bernanke play.

Bernanke and his research

Bernanke's people

Ben Bernanke was born on December 13, 1953 in Augusta, Georgia, and grew up in a small village called Dillon in South Carolina. Bernanke's grandfather, Jonas Bernanke, ran several drugstores in New York, but his career was greatly affected by the onset of the Great Depression. In 1941, he discovered a drugstore in the Dillon area and fled New York with his wife and children and moved to Dillon. Bernanke's father, Philip Bernanke, served in the U.S. Navy, but ironically, the Navy spent most of his career in the Nevada desert. There, his main job was to manage a military supply point. After retiring from the military, Philip went to the University of North Carolina at Chapel Hill to pursue a master's degree in drama, where he met Edna, a student at the University of North Carolina Women's College. Soon, Philip falls in love with Edna and returns to Dillon's hometown together. Soon after, their child, Bernanke, was born.

From a very young age, Bernanke showed extraordinary intelligence. In sixth grade, he competed in a national spelling bee and won the South Carolina state championship — in fact, if it weren't for an extra letter in a word, he would have been the national champion that year.

Bernanke spent his undergraduate years at Harvard, graduating there in 1975. After that, he went to the Massachusetts Institute of Technology on the edge of Harvard to pursue his PhD. There, he systematically studied macroeconomic theory under the guidance of the famous economist Stanley Fisher. Bernanke's own research interests were primarily the Great Depression, and his graduation thesis focused on this topic.

Bernanke received his doctorate in 1979. He then joined Stanford University as an assistant professor and was promoted to associate professor in 1983. While at Stanford, Bernanke published an important paper on the Great Depression. The paper argues that the failure of the financial system was a more fundamental cause of the Great Depression than the decline in the money supply. In 1985, Bernanke moved to Princeton University as a professor. There, he worked with his collaborators on many important articles, including the famous BGG model. Since 1996, Bernanke has served as chair of the economics department at Princeton University. During his tenure, Corporal Bernanke recruited many outstanding economists and enriched the scientific research and teaching strength of the Department of Economics. For example, Paul Krugman, the famous "big mouth" in economics and the 2008 Nobel laureate, was brought in by Bernanke during his tenure, and he became Bernanke's staunchest critic of the Fed.

In 2002, Bernanke was nominated by President Bush to serve as a governor of the Federal Reserve. In 2006, he succeeded the legendary Alan Greenspan as Fed chairman, a position he held until 2014. After leaving office, Bernanke joined the prestigious think tank Brookings Institution. He is now a distinguished fellow of the Society.

From the Great Depression to a "financial accelerator"

In terms of academic research, Bernanke's research focuses on two areas: one is the study of the economic history of the Great Depression of 1929, and the other is the theoretical discussion of "financial accelerators".

In macroeconomics, the explanation for the Great Depression has long been seen as the "holy grail." Before Bernanke, many famous scholars had given their own explanations. Keynesians, for example, believe that the Great Depression arose from a lack of effective demand, and the most famous book is Keynes himself's General Theory. Monetarists, on the other hand, believe that the Great Depression stemmed from the collapse of the money supply. In The History of American Money, Friedman elaborated on this idea in depth.

To some extent, Bernanke's explanation of the Great Depression can be considered a synthesis of the above ideas. Similar to the monetarists, Bernanke argues that the Great Depression did stem from a liquidity crunch, but that it was the gold standard that existed at the time. In his book The Great Depression, Bernanke cites a wealth of facts and figures showing that the sooner countries abandon the gold standard, the faster they recover from the Great Depression. In the relationship between supply and demand, in addition to the demand-side factors, Bernanke also discussed the influence of supply factors. In the book, he focuses on the importance of wage rigidity. He argues that because of the intense pressure on the government, the government had to maintain a higher nominal wage through administrative policies, which would obviously cause more unemployment and keep the Great Depression longer.

It is worth mentioning that through an in-depth study of the Great Depression, Bernanke understood the role of financial factors in economic development more clearly than other economists of his time. In his 1983 paper, "Non-MonetaryEffects, the Fi-Southern CrisisinthePropagationoftheGreat Depression," he focused on the transmission of financial risk by bank failures, a view that is very similar to that of Diamond and others.

From the late eighties, Bernanke's focus shifted to the more theoretical theory of "financial accelerators."

The so-called financial accelerator, as the name implies, is the amplification and strengthening of the external impact of banks and other financial intermediaries. In a 1989 paper, "Agency Costs, Collateral, and Businessfluctua-tions," Bernanke discussed the issue with his collaborator Mark Gertler. Before Bernanke, Modigliani and Miller had proposed a theory that financing structure was irrelevant, the famous MM theorem. According to MM's theorem, if the financial market is perfect, then the investment behavior of the enterprise will not be affected by the financing structure, and its value will be independent of the financing structure. But in Bernanke and Gertler's view, this hypothesis is clearly difficult to hold up in the real world. In reality, financial markets are incomplete, so the agency cost of external financing will be higher than internal financing. In this case, the investment of the enterprise will be affected by the balance sheet of the enterprise.

When a business is hit, its cash flow and net worth are affected, and this impact itself will further amplify the utility of the shock and affect its ability to finance. Then, the further tightening of financing capacity will in turn continue to depress the cash flow and net worth of the enterprise... Thus, the amplification effect of financial markets on shocks emerges. In Bernanke's view, the more imperfect the finance and the higher the agency cost, the more obvious this amplification effect is. The agency cost itself is counter-cyclical, so it will prolong the cycle and cause the cycle to amplify.

It should be noted that although the basic idea of "financial accelerator" appeared in the 1989 paper, it was officially used as a term in the 1996 paper "The Financial Accelerator and the Flight to Quality" with Gertler and Simon Gilchfist. Later, the three authors presented this idea more rigorously in their 1999 paper, "The Financial Acceleratorina QuantitativeBusinessCycleFrame-work." Since the initials of the three authors are B, G, G, G, this model is often referred to as the BGG model.

In the BGG model, the financial accelerator effect is incorporated into the neo-Keynesian model. It clearly shows how economic shocks are amplified through financial markets throughout the macroeconomy, and how the efficiency of financial markets affects the size of financial accelerators.

In addition, the BGG model provides a more solid theoretical basis for central bank intervention. In the traditional Keynesian framework, the central bank's influence on the economy is largely achieved through the effect of interest rates on real income. After considering the financial accelerator effect, interest rates have more channels for the economy: when interest rates are lowered, the net worth of enterprises will increase, which will help increase the net assets of enterprises, reduce the financing costs of enterprises, and then lead to an increase in corporate investment. Obviously, this finding was very enlightening for Bernanke's future response to the financial crisis as Fed chairman.

Strangers in the Fed

One day in early 2002, Bernanke, who was working at the school, received a call from Washington. On the other end of the line was Glenn Hubbard, then chairman of the President's Council of Economic Advisers. On behalf of President George W. Bush, he asked Bernanke if he would be interested in changing the status quo and getting out of school to work for the Federal Reserve.

After receiving this invitation, Bernanke was very hesitant. For a man like him, who has lived in an ivory tower for a long time, working for the Fed would mean giving up a lot of things: he would leave his familiar teaching and research, resign as editor-in-chief of the American Economic Review (note: the American Economic Review is the most influential journal in economics, and for economists, serving as editor-in-chief of the journal is a great honor), and even his own daughter will leave her partner and transfer to Washington. But as a macroeconomist, the urge to apply what he learned eventually convinced him, and he replied to Hubbard that he was willing to go to Washington to "attend an interview."

The "interview" was very relaxed and enjoyable. After asking Bernanke a few questions, President George W. Bush decided he was the right person to serve as a Fed governor. After some routine review, George W. Bush formally nominated Bernanke in May. In August, Bernanke was officially sworn in to join the Fed in the presence of Greenspan.

Bernanke joined the Fed at a good time for the U.S. economy, but during that time, Bernanke was not very happy. As an academic, he spent more time like a stranger in the Fed.

Under the monetary policy of monetary guru Alan Greenspan, economic growth is stable, inflation is stable, and from a macroeconomic point of view, everything is fine. However, as an expert on the Great Depression, worries about the economic crisis have always haunted Bernanke's mind. He expressed this sentiment in a speech to the National Club of Economists, which was also his first public address since joining the Fed. He pointed out that although the economy is recovering, deflation and a severe recession are still possible, and if such a situation occurs, the Fed should respond to it. Soon after, he reiterated this sentiment in two more speeches. However, most people at the time disagreed with Bernanke's views. In fact, it was not only ordinary people at the time who believed that the Great Depression would never happen again, but most economists held similar views. Robert Lu-cas, a leading figure in the school of rational anticipation and winner of the 1995 Nobel Prize, publicly declared in a 2003 speech that "the core of the economic crisis has been solved."

In 2006, the legendary Alan Greenspan, who had been at the helm of the Fed for nineteen years, stepped down and Bernanke was appointed chairman of the Federal Reserve. Under Greenspan's time at the helm of the Federal Reserve, a policy of low interest rates was adopted in order to stimulate the economy, which created a huge bubble in the housing market, which also led to the rapid development of the subprime mortgage market. At the same time, Greenspan pursued a laissez-faire policy with little oversight of innovations in the derivatives market. Against this backdrop, financial institutions package subprime loans with great risk into a variety of financial products for sale, so that the risks arising from the subprime mortgage market pervade the entire economy. It's as if the whole world has been covered with gunpowder, just waiting for the fire to be ignited.

Almost as soon as Bernanke took over Greenspan, the fire was ignited. Beginning in the spring of 2006, market expectations changed, property prices began to fall, and subprime mortgage defaults began to occur. Originally, this was just a small flame, and the market's own regulation could quickly extinguish it. But fueled by derivatives, financial leverage, and what Diamond and Rajan call credit freezes and panic selling, the small flame gradually turned into a blazing fire. By 2007, the subprime mortgage crisis had spread around the world, and the European and American stock markets had plummeted across the board, and a large number of banks and financial institutions had huge losses and were on the verge of collapse. Although the root cause of all this was left by Greenspan during his tenure, after he "brushed off his clothes", Bernanke's successor naturally became the "pot man".

Although Bernanke had always been prepared for a crisis, unfortunately he did not anticipate the exact direction in which it would occur. He certainly can't be blamed for this, in fact, in his training in economics, banks and financial intermediaries played only an obscure role in macroeconomics, and even his BGG model was often dismissed as exaggerated. In the real world, the development of financial innovation, especially the complexity of financial derivatives, is far beyond the imagination of those scholars in the ivory tower, and with standard economic training, even if you can anticipate a crisis, it is difficult to find the location of the crisis.

Fortunately, the economics training, while not allowing Bernanke to foresee and prevent trouble, was enough to keep him from panicking when a crisis occurred. Faced with the rapid exhaustion of liquidity across the board, he quickly realized that the financial risks of the entire market were concentrated in a few key financial intermediaries, and it was their rush that led to panic and runs. Therefore, if we want to save the entire financial market, we must ensure the liquidity of these financial institutions so that they can survive the crisis. He persuaded and led Fed personnel to develop and implement a series of bailout plans for key institutions. Judging from later developments, these bailouts are very important for stabilizing the financial market and curbing the spread of financial risks.

However, while these measures helped financial markets weather the crisis, they thrust Bernanke himself to the forefront. Bernanke's bailout plan, which targeted key financial institutions, left him inhuman inside and out—advocates of forceful intervention argued that Bernanke was too retracted to quickly contain the contagion; Laissez-faire, on the other hand, argue that Bernanke's advocacy of bailing out large greedy financial institutions is a distortion of the market that is likely to contribute to their moral hazard in the future. It is conceivable that Bernanke must have faced extremely great psychological pressure at that time. In fact, he himself struggled when he developed these relief plans. As a scholar, he believed in free markets and hated financial oligarchs who used the market for profit, but in the circumstances, he had to save the financial oligarchs who suffered from themselves.

The crisis came violently, but it also went relatively quickly. Soon after, the chaos in financial markets was largely over, but Bernanke did not take it easy. When the crisis passes, the next step is economic recovery. But how to drive all this? At the time, the prevailing view was to pursue a loose monetary policy and maintain a high inflation rate until economic growth and employment recovered. But as a good monetary economist, Bernanke was hesitant to take such a radical approach. He certainly knows that loose monetary policy is better for growth, but he also knows that inflation is like a drug, once used, it is difficult to stop, and the damage to the economy can be very fatal. After taking into account the two goals of economic growth and price stability, Bernanke chose a more moderate path, maintaining inflation at a relatively dovish position through quantitative easing.

Obviously, this plan has met with a lot of criticism. The interventionist accused this of being too cautious. For example, the "big-mouthed" Krugman, who was personally recruited by Bernanke to Princeton, publicly criticized Bernanke's Fed for its "shameful" negative attitude on his blog, and Bernanke himself was denounced as "cartilage". At the same time, laissez-faire supporters criticized Bernanke for using monetary policy to distort the economy's self-regulation. For example, the economic historian Allan Meltzer argues that the high unemployment rate plaguing the United States at the time was not a currency problem, and that Bernanke's attempt to regulate the economy with monetary policy was actually doing something beyond its means.

In 2010, Bernanke served a full term as Fed chairman and received 70-30 votes when his re-election bid was considered in the Senate, compared with 89-4 when Greenspan was last re-elected. Comparing the two shows how controversial this hero who helped the United States through its most difficult times is.

In his second term, Bernanke's main task remained to walk a tightrope between the goals of inflation and economic growth. In order to accommodate this goal, he carefully formulates quantitative easing policy while carefully assessing the state of the economy in order to exit quantitative easing at the right time. However, Bernanke did not end QE during his tenure. When Bernanke's term expired in January 2014, the task of walking the tightrope between the two goals was dumped on his successor, Yellen. Fortunately, by the time Bernanke left office, the economic situation in the United States had improved significantly, and social evaluation of him had begun to improve.

When Bernanke stepped down as Fed chairman, he could finally return to academia and observe the Fed and the economy as a bystander. He chose to join the Brookings Institution, a prestigious think tank in the United States, and interestingly, the topic of his chosen research was still "Promoting a Strong Economic Recovery from the Great Depression."

How to face the next crisis

Now, more than a decade has passed since the 2008 financial crisis. Under the washing of the years, everything seems to be back to normal. Every day, banks and financial institutions routinely swallow huge sums of money to feed the economy into liquidity; Wall Street elites, as usual, are chasing every opportunity. Everything seems to be beautiful.

But is it all really durable? Are the years really so quiet? In fact, behind the apparent calm, the shadow of crisis has never gone away. Epidemic risks, energy crisis, supply chain difficulties, Russia-Ukraine conflict... Each event can become the seed of the next crisis, which can have a "self-actualization" effect like what Diamond and Davidger put it, amplifying into a huge crisis.

So, can we take it in stride when the next crisis hits? From now on, the situation is actually not optimistic. Hegel said, "The only lesson that mankind learns from history is that mankind does not learn from history." The development of these more than ten years seems to confirm Hegel's foresight once again. In the aftermath of the last crisis, while all countries' financial systems have made some tinkering, it fundamentally seems that no effort has been made to prevent real risks in advance. In fact, during this period, many new risk points such as real estate and Internet finance are quietly growing, and they will become the fuse of a new crisis with only one opportunity. In this sense, this Nobel Prize can be said to be a wake-up call to remind us that we must learn from past crises and prepare for the next one that may come at any time.