Hamish McRae: We must get the blame game out of the way and move on

It would be astounding if the fall in UK output were anything like as bad as in the 1930s

South Africa is a better model than Germany. There was something of the Nuremberg trials about yesterday's grilling of the former leaders of HBOS and Royal Bank by the Select Committee but more of South Africa's Truth and Reconciliation Commission too. That is good. People may feel angry about what has happened, as our Prime Minister is reported to be. But anger achieves nothing. What matters now is how it is all put back together again.

Ed Balls hasn't helped. He is thoughtful and sensible and decent but to say that we face the worst recession for a century is plain wrong. In the narrow sense that our financial institutions are under greater pressure than at any stage since the 1930s is probably correct and in some respects our banks (though not American or Continental ones) are under more pressure now than then.

But it would be astounding were the fall in British or global output to be anything like that which occurred in the 1930s. The much better parallel would be the 1970s, with the economic mayhem that followed the collapse of the fixed exchange rate system. But Mr Balls was six months old when sterling was devalued in 1967 and nine when the IMF rescued the Government in 1976, so he can be forgiven for not recalling the details of all that.

So what is going to happen? I'll tell you. It would be absurd to predict the precise trajectory of the downturn and subsequent recovery but subject to one proviso you can sketch the broad outline. That proviso is that there will not be some huge error of policy or some huge global political catastrophe that would blow to pieces all economic predictions. Then all bets are off. But subject to that... well, see what you think.

The starting point is that there is serious global banking weakness, much more serious than was appreciated either by the banks or the monetary authorities. But that, at a cost, is being fixed. I like the more measured response which came from Alistair Darling in these pages yesterday, where he quoted Keynes that he "would rather be roughly right than precisely wrong".

The Chancellor was referring to UK policy but you could apply that to the response by governments around the world. When we question the detail of the policy response around the world we tend to forget that policy will never be optimal. It just has to be good enough. That phrase was put to by one of the officials who choreographed the rescue of Northern Rock: "We didn't do it well, but we did it well enough."

So while we could criticise elements of the British response, in particular the cut in VAT, you have to remember that we are learning as we go along. Similar criticism could be made of the US response, the German, the Japanese, the Chinese, whatever. But the broad approach of first making sure the banking system is working and then figuring out whether it is possible to give some boost to demand is on the right lines.

Go back to the experience of the 1970s. There was a global inflationary crisis, the worst inflation from a world perspective in recorded history. It was much more than the great inflation of the 16th century, when prices "only" quadrupled. We did not know the precise way to fix it, just as we don't have much of a road map now. But the world cobbled together a number of disciplinary techniques, of which the most important was money supply targets, which brought inflation under control. Our present inflation targets are a refinement of that device.

Now, to fix the banks there are a number of options. There are the various methods being used to boost liquidity generally. There is the possibility of temporary full nationalisation of the weakest banks, as used in Scandinavia in the 1990s. There is the idea of a "bad bank" that takes over the questionable loans of banks and then works these off over a period. That worked well in the US after the Savings and Loans crisis and here after the Lloyd's insurance market losses.

Fixing the financial system is a necessary precondition for resumed global growth – necessary but maybe not sufficient. Or rather, eventually growth would recover of its own accord but government intervention can probably speed up the process. Here we should not underplay the huge boost to demand that is being banged into the world economy at the moment.

What the UK is doing is quite small by world standards because we are limited by our weak fiscal position. The programmes of the US, Germany and Japan (and as far as I can see, China) are all much larger in relation to GDP than our own. But of course the beauty of all this is that we help each other. More demand in the US or Europe helps us too and vice versa. We cannot feel the effect yet and I am afraid global output has further to fall. But a year from now the world economy won't still be going down at anything like this rate and may even have started to recover.

And the fall, peak to trough? Well the IMF reckons that it will be more serious for the developed world than any post-war cycle and that output will actually fall for this part of the world. However thanks to the rise of the emerging economies, overall global output will continue to inch upwards right through the trough. As for Britain, maybe the IMF is right in saying we will do worse than other large developed nations, but let's see. I have a feeling they will turn out to be too pessimistic.

What worries me is not what will happen in 2010. By then, or by 2011 at the latest, recovery will be secure. What worries me is the quality of that recovery. The entire developed world will be saddled with a massive increase in public debt – not as big as after the First or Second World Wars but big none the less. The disruption will have led to international trade and financial tensions. Public finances will be devastated by weak tax revenues everywhere.

The pull out will be slow and difficult. Debts, personal and public, take a while to work off and until these are under control there won't be much left over to enjoy ourselves. If this goes for us in the UK, it also goes for much of Continental Europe and North America too.

Financial markets, faced with all this, will continue to be frightened. So much wealth has been lost already and more losses will be revealed in the coming months. It is not realistic to expect a recovery in market sentiment until some sort of turn in the world economy comes into sight, for typically, financial markets turn a few months ahead of the economic situation but first they have to see some sort of base from which things can't get any worse and we are still some way from that.

Meanwhile we do need reconciliation. To judge by conversations in the past few days many people are probably not ready for that yet but the sooner we are, the better the shape of the economy through the eventual recovery. There have been monumental errors made by all: bankers of course, but also regulators and borrowers. The Government has mismanaged national finances, making similarly optimistic assumptions as the rest of us. But we must get the blame game out of the way and move on.

h.mcrae@independent.co.uk