Critics sometimes ask what practical good economic theory has done. The Nobel Prize in Economic Sciences awarded to Ben Bernanke on Monday along with Douglas Diamond of the University of Chicago and Philip Dybvig of Washington University in St. Louis provides a rejoinder. The laureates independently developed the theoretical foundations for why banks exist and why bank panics hurt. Mr. Bernanke put those theories into practice when the stakes could scarcely have been higher: as Federal Reserve chairman during the global financial crisis of 2007-09.
All of finance deals with a problem known as “information asymmetry”: Borrowers know more about their creditworthiness than lenders do. Savers can’t undertake all the due diligence necessary to determine who is a safe borrower. Moreover, they often want their money back without notice, before the borrower’s project has earned a return.
