Financial Intermediation and the Economy

Abstract

The 2022 Sveriges Riksbank Prize in Economic Sciences in Honor of Alfred Nobel rewards foundational research on the role of banks in the economy, particularly during financial crises. Financial intermediaries such as traditional banks and other bank-like institutions facilitate loans between lenders and borrowers, and thereby play a key role for the allocation of capital. They enable households to get a mortgage to buy a home, farms to get a loan to buy a harvesting machine, and firms to get a loan to build a new factory. However, financial intermediaries also play a key role during times of significant economic distress. For example, during the Great Depression in the 1930s, a large number of banks failed and the credit supply contracted significantly, further deepening and prolonging the recession. Another example is the 2007-2009 Global Financial Crisis, which arguably started in the financial sector, and financial intermediaries were at the core as the crisis unfolded. This crisis led to a long recession, sometimes called the Great Recession. The fact that banks and other financial intermediaries perform important functions but at the same time can be associated with devastating crises poses a critical challenge to policymakers.