Hamish McRae: It won't be the Great Depression all over again – or even the '70s or '80s

The mills grind on. One of the troubles with this banking crisis is that the official response to it has been very confusing. This is a global problem that originated in the US, so what the US does is of prime importance. But although financial institutions are international, regulation is national. And the prime duty of national governments is to preserve the security of their systems. So we are now moving into competitive regulation, where individual governments such as Ireland and Greece seek to improve the position of their own system relative to others. There is nothing wrong with that. Why shouldn't regulatory competition bring benefits, just as other forms of competition do?

Whenever things become really confused, I find it helpful to try and fix what is happening in some sort of historical framework. There is a natural hyperbole to the past three weeks' events – that is what is happening is unprecedented – which you have to fight against. There are lots of precedents, though none are perfect. There have been many financial panics in the past, all different in detail but all having some similar characteristics. Most have settled down and normal business relations have been resumed; a few have been particularly badly handled, ending in some sort of economic disaster.

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Governments are inevitably involved – they always have been. One of the great gifts of government through the ages has been the provision of money. The first emperor of China, Qin Shi Huang (259 BC to 210 BC), is known here for the Great Wall and the Terracotta Warriors, but arguably his greatest positive contribution to China was to give it a common currency. The Roman denarius was still circulating in Europe in the Middle Ages. The European thaler, common from the 1400s onwards, is remembered in the word "dollar" today – try saying "dollar" in a spoof American accent and you will hear its origins.

But if governments have been responsible for money – and occasionally irresponsible, witness the great German inflation of 1923 and Zimbabwe today – it is the private sector that has been responsible for banking. There were rudimentary money lenders in Rome, and I suppose long before that, but banking as we know it now was developed in northern Italy in the Middle Ages, with what is now the oldest still-functioning bank, the Monte dei Paschi di Sienna, founded in 1492.

So money has always been a public good, whereas banking has almost always been a private service. There are exceptions, such as nationalised banks and mutual savings institutions, but basically that has always been the rule. The trouble was that there was no bridge between the two entities, money and banking, until central banking was invented by the Dutch and developed here with the Bank of England. The Bank was a privately owned institution until nationalised in 1946, but it has always been the servant of the government, as have central banks everywhere from the US to Japan to China.

So it is through the central banks that governments have normally acted to provide order for the financial system. Their most basic role is to issue the currency. In extremis, they have to flood the banking system with funds because only they can create the stuff. Economic history is littered with examples of this, with the Baring crisis of 1890 being perhaps the most famous in Britain. Unlike in the US and on the Continent, the UK did not have a serious banking crisis after the stock market crash of 1929 – one of the reasons why this country had the fastest economic recovery in the early 1930s.

When calibrating what is happening now, a number of people have referred back to the experience of the 1930s. There has been a fair bit of that in Congress during the past week. But while it may be helpful to remind people of the consequences when banks are allowed to collapse, just as it is helpful to remind them about the dangers of protectionism, it is stretching things to suggest the world faces a meltdown on that scale. We have learnt since then that no democratic government can allow major banks to lose their depositors' money. Savers have to be protected, though shareholders don't. There have been wobbly cases: BCCI, for example was allowed to go under and many depositors did lose money, but that bank was deemed not to be core to the UK banking system. So there has been a little ambiguity over the position of small banks, but the "too big to fail" argument has normally prevailed. There is an implicit guarantee by the modern state that all bank deposits are guaranteed, and all Ireland and Greece did last week was to make that implicit guarantee explicit.

The parallel that seems to me more appropriate is the experience of the 1970s. Viewed globally, that was not a banking crisis but a monetary one. In Britain we had the secondary banking crisis, which was contained by swift action from the Bank of England, and was secondary to the collapse of confidence in currencies worldwide. For a while, inflation was allowed to spin out of control, reaching double digits in many countries. Eventually it was brought back but at huge cost in lost output and large-scale unemployment. We did things pretty badly in Britain, ending up with the loan from the International Monetary Fund in 1976, but no one came well out of the experience.

With hindsight we can now see that policymakers coped very badly with the great inflation of the 1970s, but – and this is my big point – even a poor policy response did not result in a global crash akin to the 1930s.

Coping with a loss of confidence in the banks is much easier than coping with a loss of confidence in the currency itself. One is a commercial failure that the state has to patch up; the other is a failure by the state itself. So even if the world's monetary authorities continue in their fragmented and sub-optimal response to this crisis, it is very hard to see anything as bad as the 1970s and 1980s recessions hitting us again.

We are not through this by any means. Already there are disturbing signs that shortage of credit is starting to hit the real economy both here and elsewhere. A few countries, including Ireland, are officially in recession, as defined by having two successive quarters of negative growth. So there will almost certainly be a recession in the UK too. But looked at historically, there is little reason to believe that this could be as deep or prolonged as the recessions of the 1970s or 1980s, and as far as the UK is concerned, the balance of probability remains that this need not be as serious as the slump of the 1990s. Many people may have had their faith in the banking system seriously battered, but unlike a generation ago, we have not lost faith in money itself.

It didn't rein in the boom. But now the Bank must put a stop to the bust

Half a percentage point or only a quarter? There is a powerful case for the Bank of England to cut interest rates next week. The argument runs like this.

First, the central banks of the world need to try and restore confidence in the banking system. That is their historic role. Yes, they have also had the brief of keeping down inflation in the past 20 years, but stability must come first.

In the US, the Federal Reserve has already cut rates several times and does not have much firepower left. In any case, the problem is not principally the cost of funds; it is the scale and uncertainty of the duff assets on bank books. On the Continent, the European Central Bank actually raised rates recently – something that looked a bit rum at the time and even more so now. Here in the UK, we can do something. The question is about the profile of rate disarmament – how soon and how fast – rather than whether it should happen at all.

The case is reinforced by the most recent data. Consumption seems to have become very weak, services output is flat and the manufacturing and construction outlook is really rather grim. If you lean against a trend early, you don't have to lean so hard later on. I don't think there is any doubt that the Bank should have leant harder against the runaway housing boom 18 months ago; now it should not make the same mistake in reverse.

Inflation? Yes, it is still very high and will remain so until the rises of the commodity and energy boom move out of the system. But the job of the Bank is to look forward.

The case for an exemplary half-point cut would be to signal that the authorities really want to help. But it might scare people and a quarter point cut, with the implication that this is the start of a long downward trend, might be more effective. Wait a month? The only case for doing so would be to see what the Treasury will do in the pre-Budget report, but that will be such a heavy and depressing meal that maybe we need a little aperitif in advance.