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US economic growth rebounded strongly in the third quarter amid a shrinking trade deficit, but that overstates the economy’s health as domestic demand was the weakest in two years because of the Federal Reserve’s aggressive interest rate hikes.

The Commerce Department’s advance third-quarter gross domestic product report on Thursday also showed residential investment contracting for a sixth straight quarter as the housing market buckles under the weight of surging mortgage rates. While overall inflation slowed substantially from the second quarter, price pressures continued to bubble.

Still, the rebound in growth after two straight quarterly declines in gross domestic product (GDP) was further evidence that the economy was not in a recession, though the risks of a downturn have increased as the Fed doubles down on rate hikes to battle the fastest-rising inflation in 40 years.

“Despite the shiny headline number, a look under the hood shows a much grimmer picture of the US economy, one that is clearly losing steam,” said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. “With the full effect of past and future Fed rate hikes still to be felt, the economy appears poised for a modest downturn in the first half of next year.”

GDP increased at a 2.6 percent annualized rate last quarter after contracting at a 0.6 percent pace in the second quarter. Economists polled by Reuters had forecast GDP growth rebounding at a 2.4 percent rate. Estimates ranged from as low as a 0.8 percent rate to as high as a 3.7 percent pace.

The trade deficit narrowed sharply in part as slowing demand curbed the import bill. Exports also increased for much of the quarter. The smaller trade gap added 2.77 percentage points to GDP growth, the most since the third quarter of 1980.

The Royal Swedish Academy of Scienceshas decided to award the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2022 to

Ben S. Bernanke
The Brookings Institution, Washington DC, USA

Douglas W. Diamond
University of Chicago, IL, USA

Philip H. Dybvig
Washington University in St. Louis, MO, USA

“for research on banks and financial crises”

Their discoveries improved how society deals with financial crises

This year’s laureates in the Economic Sciences, Ben Bernanke, Douglas Diamond and Philip Dybvig, have significantly improved our understanding of the role of banks in the economy, particularly during financial crises. An important finding in their research is why avoiding bank collapses is vital.

Modern banking research clarifies why we have banks, how to make them less vulnerable in crises and how bank collapses exacerbate financial crises. The foundations of this research were laid by Ben Bernanke, Douglas Diamond and Philip Dybvig in the early 1980s. Their analyses have been of great practical importance in regulating financial markets and dealing with financial crises.

For the economy to function, savings must be channelled to investments. However, there is a conflict here: savers want instant access to their money in case of unexpected outlays, while businesses and homeowners need to know they will not be forced to repay their loans prematurely. In their theory, Diamond and Dybvig show how banks offer an optimal solution to this problem. By acting as intermediaries that accept deposits from many savers, banks can allow depositors to access their money when they wish, while also offering long-term loans to borrowers.

However, their analysis also showed how the combination of these two activities makes banks vulnerable to rumours about their imminent collapse. If a large number of savers simultaneously run to the bank to withdraw their money, the rumour may become a self-fulfilling prophecy – a bank run occurs and the bank collapses. These dangerous dynamics can be prevented through the government providing deposit insurance and acting as a lender of last resort to banks.

Diamond demonstrated how banks perform another societally important function. As intermediaries between many savers and borrowers, banks are better suited to assessing borrowers’ creditworthiness and ensuring that loans are used for good investments.

Ben Bernanke analysed the Great Depression of the 1930s, the worst economic crisis in modern history. Among other things, he showed how bank runs were a decisive factor in the crisis becoming so deep and prolonged. When the banks collapsed, valuable information about borrowers was lost and could not be recreated quickly. Society’s ability to channel savings to productive investments was thus severely diminished.

“The laureates’ insights have improved our ability to avoid both serious crises and expensive bailouts,” says Tore Ellingsen, Chair of the Committee for the Prize in Economic Sciences.