In 1847, a Dr Hyde Clark wrote a paper entitled Physical Economy - a Preliminary Inquiry into the Physical Laws Governing the Periods of Famines and Panics. His paper was published in the Railway Register.

It opens with the comment: “We have just gone through a time of busy industry and are come upon sorrow and ill-fortune; but the same things have befallen us often within the knowledge of those now living...a period of bustle, or of gambling, cut short in a trice and turned into a period of suffering and loss, is a phenomenon so often recorded, that what is most to be noted is that it should excite any wonder.” We can say that again in 2008.

The 1840s were the period of the great railway mania and of Sir Robert Peel's Bank Act. They were one of the periods in which economists were concerned to explain economic crises and, if possible, prevent them recurring. We are back in such a period and should expect a similar public debate. Within a few days, the 2008 crisis has overwhelmed leading banks in the United States and Britain; the US Administration has had to pledge unimaginably large sums in defence of the surviving banks. The US Government has taken on contingent liabilities of more than $1 trillion.

At least Dr Hyde Clark enables us to put this crisis in ahistoric context. There had been crises before the 1840s, including such spectacular events as the collapse of the Dutch tulip mania in the 1630s. There have been crises since the 19th century, including the Great Wall Street Crash of 1929. We are not dealing with a unique phenomenon now, but with a recurrent event that the world economy has always survived in the end.

In 1847 Samuel Jones Loyd, a London banker who became Lord Overstone, wrote his classic description of the natural lifecycle of trade. “We found the state of trade subject to various conditions which are periodically returning; it revolves apparently in an established cycle. But first we find it in a state of quiescence, - next improvement, - growing confidence, - prosperity, - excitement, - overtrading, - convulsion, - pressure, - stagnation, - distress, - ending again in quiescence.”

We can take it that our present stage is one of “convulsion”, and that we may be moving on through pressure towards stagnation and distress. Anything that could be called recovery may be some way away.

A number of economists have tried to construct new theories that would stabilise the trade cycle and at the same time stabilise prices. This has engaged the attention of economists of the standing of David Ricardo, W.S. Jevons and Maynard Keynes, of the English school, and of the American, Irving Fisher. There was also a brilliant contribution from Ludwig von Mises, of the Austrian school, who came to the conclusion that this task might be impossible. That will not stop people trying again and again.

The objective that is shared by the reformers is simultaneously to stabilise prices and activity through control of interest rates and money supply. The first problem is that stable prices and rising activity may be incompatible objectives. An austere chairman of the Federal Reserve, such as Paul Volcker in the early 1980s, may bring prices under control at the expense of economic growth; a more exuberant chairman of the Federal Reserve, such as Alan Greenspan in the 1990s, may make the opposite choice. He may boost economic growth at the cost of higher prices or asset values.

There are other difficulties. Even if one accepts the monetarist view that an increase in the supply of money is likely to raise prices, there is no consistent correlation. On one occasion, a rising money supply will have little effect on prices or activity; on another occasion, the monetary kettle may boil over at the first whiff of additional funds.

There is also a difficulty that von Mises regarded as insuperable: the question of timing. In his 1928 paper on Monetary Stabilisation and Cyclical Policy, von Mises argued that bankers may be able to foresee the pattern of monetary developments, but will not be able to foresee the timing of the crisis.

Indeed, this has been the common experience of recent years. There has never been any lack of warnings of the current crisis, many made by informed people who thought the Greenspan policies could lead only to disaster. In the words of von Mises: “Would the banks be able to make the boom eternal? They cannot do this. The reason they cannot is that inflationism carried on ad infinitum is not a workable policy.” In the end, one of the succession of bubbles that Mr Greenspan inflated was bound to burst. When the housing bubble burst, it brought down the existing banking structure and nearly bust the whole machine.

On the morning after the crisis, the world's central bankers are still primarily concerned with the need to save the system, and rightly so. However, they will still be under political pressure to raise the rate of expansion as soon as possible. The pressure is greatest in the United States, although next year will be a post-presidential election year when it may be politically possible to stabilise the economy.

There is a fundamental difference between the underlying attitudes of America and Europe, with Britain on the same side as Europe. In the United States the grossest blunders have been made as a result of overconfidence and the desire to create bogus bonuses by manipulating the system. Yet Wall Street still hopes that the music has not stopped for good.

The European Central Bank, under Franco-German leadership, is much more cautious. Europe understands inflation. The Bank of England sympathises with the European view, though there are still members of the Government who want to cut taxes or raise public expenditure. I am glad, in these circumstances, that interest rate policy is in the hands of the Bank of England.

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