Gasoline shortages: what the work of the 2022 “Nobel” prize winners in economics teaches us
by Florian Léon, University Agency of the Francophonie (AUF)
For more than a week, French motorists have been facing a fuel shortage situation following strikes in several refineries. The news of the past week was also marked, in a much more discreet way, by the awarding of the Bank of Sweden prize in honor of Alfred Nobel to three American economists for their work on banks and financial stability.
Although these two events have nothing in common, the work of Douglas Diamond and Philip Dybvig, who received the prize alongside Ben Bernanke, former chairman of the US Federal Reserve (Fed), sheds some interesting light on the current situation in France.
In 1983, Diamond and Dybvig wrote a seminal article that made it possible to understand that what makes banks exist is also a source of their fragility. The existence of banks is explained by their role as intermediaries between savers and borrowers. The former seek to place their savings in safe and liquid investments, i.e., available at any time. Borrowers need funds, mobilized for a fairly long period, in order to invest.
In the absence of a bank, it is impossible to transfer surplus savings to borrowers because of the different time frame. The banks ensure this intermediation by collecting the savings available in the short term in order to lend them in the long term. By carrying out this maturity transformation, banks contribute to investment and thus to economic activity.
Diamond and Dybvig have highlighted that this intermediation activity is also what makes banks inherently fragile. Banks are structurally in a position of illiquidity because part of the savings is not available in the short term since it is lent over the long term. Under normal circumstances, this situation does not pose a problem. Only a limited part of the total savings is withdrawn every day. Banks are therefore not obliged to have all the savings placed by depositors at their disposal.
Diamond and Dybvig are interested in bank runs, in which many savers want to withdraw their savings at the same time, putting banks and even the banking system in difficulty. The origins of these banking panics are multiple, ranging from doubts about the solvency of a bank to political decisions such as in Cyprus in 2013 when the government wanted to tax deposits.
The interesting point of Diamond and Dybvig’s analysis is to show that even if the withdrawals initially involve only a limited number of savers, they can induce a rush to the counters of all depositors due to self-fulfilling prophecies and lack of coordination. Suppose a proportion of savers decide they want to withdraw their deposits. If other depositors begin to doubt the bank’s ability to meet withdrawal demands, then it is rational for them to withdraw their deposits. If these depositors arrive too late, they will no longer be able to access their money, since the withdrawal principle is first come, first served.
From that moment on, all the depositors will rush to the bank counters to withdraw their deposits. The bank will not be able to serve all these requests and it will be faced with a situation of illiquidity that may even turn into a solvency risk (if the bank has to sell its assets in a hurry to obtain liquidity). It is possible that the phenomenon will spread quickly to other banks, for example if depositors who have accounts in several banks withdraw their funds in other banks.
Although this model is very simple, it sheds some light on the current fuel shortage. The shortage is primarily due to the strikes that have affected several refineries. However, the strikes do not explain the shortages observed at several service stations, particularly in areas not initially served by the closed refineries. One explanation for the shortages is the phenomenon of self-fulfilling prophecies, as revealed in the Diamond and Dybvig model.
The “Nobel” solutions…
As with banks, gas stations have only a limited amount of gasoline and the principle that applies is that of queuing. Faced with the alarming news, many motorists anticipated an inability of the stations to serve everyone. They rushed to the pumps even though their needs were limited, depleting stocks and creating a situation of shortages.
It is useful to take the analogy a step further by looking at the proposed solutions put forward (or ignored) by Diamond and Dybvig to see how they might apply in the case of fuel shortages. The two economists propose two solutions to counter the rush to the pumps.
The first solution is an insurance system that allows each citizen to have his or her savings covered in case of bank failure (100,000 euros per bank and per depositor within the European Union). The objective of this system is mainly preventive, to avoid a panic, but it is useless once the crisis has materialized.
The second solution is more useful in case of panic. It consists of preventing agents from withdrawing money beyond a certain threshold. In practice, this solution has taken the form of a withdrawal limit. A similar solution has been applied at some gas stations by limiting the maximum capacity at each fill-up or by prohibiting the filling of additional tanks. The risk is that motorists will panic and go to the pump more often.
A solution closer to the Diamond and Dybvig model would be to implement “fuel vouchers” that would be attached to each motorist or vehicle and could be modulated according to activities (priority or not), even with the possibility of being exchanged. This solution may be theoretically attractive, but it is technically very difficult to implement in such a short time frame.
… and the others
It is also interesting to study solutions not considered by Diamond and Dybvig. The authors ignore in their analysis the role of money creation (which is a limitation of their model). Faced with liquidity crises, the central bank can inject liquidity into the banking system in order to give banks oxygen.
In the case of gasoline, the government has thus begun to use strategic stocks to reduce tension. Nevertheless, the analogy with the banking system has its limits. Unlike central bank money, fuel is not created ex nihilo. This solution therefore implies reducing these stocks, with the risk of running out if the crisis persists.
Finally, it is useful to ask why economists have not thought of price regulation. One solution to both problems would be to change the way in which the resource is allocated according to a price principle rather than a rationing principle (queuing). In concrete terms, banks could charge for withdrawals in proportion to the amount withdrawn, or they could play on the price of fuel.
It is also clear that prices at the pump have risen since the beginning of the shortage, especially in the most densely populated areas.
This solution has two essential limitations. On the one hand, raising prices is politically explosive in the current inflationary situation. This choice would be tantamount to giving priority to the better-off, at the risk of increasing tensions and thus the origin of the problem. On the other hand, it is doubtful that price regulation is the best tool in a panic situation, when economic incentives lose their effectiveness.
The experience gained could be used to anticipate future crises in order to curb as quickly as possible the phenomena of self-fulfilling expectations that are at the heart of the current difficulties.
Florian Léon, Research officer at the Foundation for International Development Studies and Research, University Agency of the Francophonie (AUF)
This article is republished from The Conversation under a Creative Commons License. Read the original article.