The turmoil on global stock, bond and currency markets in the past week is a useful but unpleasant reminder that government action in a crisis is necessary, but far from sufficient, to avert disaster.

The massive bank bailout plans hastily convened in the US, Europe and parts of Asia may have prevented the collapse of the world’s financial system. Avoiding total failure is not in itself good news, however. Events last week have showed that the dysfunctionality in markets is so pronounced that even public guarantees of the financial sector are not enough to save the world from the baleful consequences of failing hedge funds, embattled insurance companies and teetering emerging markets.

Much more important, it is now evident that we are in a recession that is almost certain to be long and arduous. That would cause a comprehensive retreat from risk even in a relatively normal business cycle but in the current circumstances it is enough to breed something close to continuing panic. No one, it seems, is safe.

So once again, the world turns to the economic authorities for help. This week, attention is on the big central banks, which are again expected to cut interest rates to lift the gloom. But can rate cuts offer much succour?

The US Federal Reserve has a scheduled policy meeting today. This month it cut its key overnight interest rate by 0.5 percentage points to 1.5 per cent, as part of a coordinated rate reduction by central banks around the world. Today, markets expect another half-point cut, taking the target base rate to 1 per cent - equalling its lowest level in the past 50 years.

What the Fed does today may not make much difference, however - despite the current official target of 1.5 per cent, the overnight rate has been hovering slightly below 1 per cent, pushed there by central bank action. A week ago it hit 0.67 per cent, its lowest since 1955.

Expectations are growing that the Bank of England and the European Central Bank will also cut rates. But there is anxiety among many that slashing rates may not be the panacea it has seemed for so long.

This trick worked well after the stock market crash of 1987, again during the recession of the early 1990s and once more after the collapse of the tech bubble in 2000. It seemed to suggest that rate cuts were paracetemol for the economy – a few doses and the pain was over. Economists knew better. Rate cuts almost always have unpleasant consequences. In 1987 an overly accommodative monetary policy helped to reignite inflationary fires that had to be doused with higher interest rates - and a recession in the next few years. The Fed’s response to the bursting of the tech bubble is blamed by some for the mess the world is in now: as easy money led to a housing boom and subsequent bust that has come close to bringing down the financial system.

Today the concern is different. Almost no serious economist now thinks the world is really at risk of inflation; the fear is now deflation.

With global stock markets down about 50 per cent in a year, house prices in many major economies expected fall to at least 25 per cent below their peak, and energy prices less than half what they were a few months ago, the world is in the grip of a deflationary spiral.

So lower rates may make no difference. The Great Depression shows that aversion to risk can be so great that no incentive can persuade investors, businesses and consumers to do anything other than hoard cash. As prices and incomes fall, cash becomes more valuable. The value of debt increases as the ability to service it declines with falling incomes and corporate profitability. If an economy falls into this liquidity trap, as happened in the US in the 1930s and in Japan in the 1990s, it can be hard to escape.

What’s needed is aggressive preemptive action - interest rates must be reduced as low as is practicable before things get irretrievable. This may sound extreme when the inflation indicators still suggest that prices are not just rising but are rising at a rate not seen in almost 20 years.

But policymaking should weight the balance of risks - upside and downside - and respond accordingly. It’s hard to find anyone who thinks that today’s global economy presents a lot of upside risk.

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