A few years ago, before he became Chairman of the Federal Reserve, the US central bank, Ben Bernanke gave a speech honouring the 90th birthday of the great economist Milton Friedman. Mr Bernanke, then a member of the Fed’s board, is an academic expert on the history of the Great Depression. In keeping with his vocation’s reputation as the dismal science, he took the festive opportunity to address one of Friedman’s central arguments, that the misery of the 1930s was not some unavoidable catastrophe, as some had argued, the inevitable reckoning that followed years of excess, but the result of unnecessary policy mistakes by the central bank. He ended the speech with a salute, an admission about the Fed’s responsibility, and - given where he finds himself today - a bold promise: “You’re right. We did it. We’re very sorry. But, thanks to you, we won’t do it again.”

This week Mr Bernanke’s words and the spectre of the 1930s were haunting America. On Monday, after the failure of the US banking bailout plan in Congress, the stock market recorded its second-biggest one-day decline, in percentage terms, since the infamous Black Thursday, October 24, 1929, the start of the Wall Street Crash.

It seemed to some merely the latest milestone on the now inevitable path back to another Great Depression. The turmoil in the markets over the past year is without doubt the worst period of financial distress in three quarters of a century.

So far, of course, the weakness in the US and global economy - as measured by unemployment, economic activity, bank failures and almost any other variable - is only a fraction of what occurred in the 1930s. The worry, however, is that the situation is deteriorating rapidly and could soon start to resemble those terrible days.

But while a recession - a painful, cyclical period of contracting economic activity - now seems inevitable in the US, Britain and Europe, as Mr Bernanke said at that birthday event, a depression - a longer period of collapsing output and soaring unemployment - can still be avoided.

The great advantage that today’s policymakers enjoy over their predecessors 75 years ago is that they have the benefit of learning the lessons from that disastrous experience. The only question is: will they?

The Great Depression in the US lasted from 1929 to 1933. In that period output contracted by about 25 per cent; one in four of the population was unemployed; prices fell persistently and the real value of money declined precipitously. The grainy black-and-white images from the time - bank runs, long queues at soup kitchens - are ingrained in the popular imagination like no other period in economic history.

For a long time economists believed that the Crash of 1929 was a primary cause of the Depression, as the decline in wealth from lower share prices produced a broader collapse in spending power and confidence. In 2008, with US equities now 22 per cent down from their peak, and house prices down by a similar amount, if that analysis is true, it might suggest a similar slump is already on the way.

But subsequent revisions to the economic data showed that the US recession began in August 1929, two months before the Crash. The stock market decline was more a reaction to, rather than a cause of, the deteriorating economic conditions.

There was no particular reason why the recession should have been much worse than the recessions that occurred every few years in the early 20th century. One mistake was tight monetary policy. The Fed and other central banks actually raised interest rates in the early part of the Crash, partly to defend a monetary system that was unsuited to deal with the crisis. In those days most countries tied the value of their currency to the gold price, and, as investors pulled their money out of the US and put it into gold, the Fed was forced to raise interest rates.

These days there seems much less danger of such a mistake. The Fed has cut interest rates aggressively in the past year. Other central banks have been less willing to do so, and risk repeating the error, but with inflation high real interest rates (the difference between the actual level and the rate of inflation) policy is nothing like as restrictive as it was in the early 1930s.

But the key error that turned a recession into the Depression has powerful echoes today. In 1930-33 banks across America failed in unprecedented numbers as rumours circulated about the health of financial institutions and anxious depositors withdrew their money. By March 1933 the situation was so grave that Franklin Roosevelt, the new President, declared a banking holiday and all banks were closed. Almost half never reopened.

This is where the parallels with today’s crisis are scarily powerful. With the exception of Northern Rock in Britain, there have been no bank runs by depositors this time around. One of the consequences of the disasters of the 1930s was the creation of a deposit protection scheme that now guarantees the first $100,000 of every customer’s money in an insured bank. But in the past few weeks we have seen bank runs of a different sort: not by retail depositors but by money markets.

As rumours about the viability of dozens of banks have swirled, banks have stopped placing their money with each other for anything other than a few days at a time. This is having almost exactly the same effect that traditional bank runs had in 1930-33; starved of cash, banks are retrenching and shutting down lending. It was this dramatic contraction of credit that turned the recession of 1929 into the Depression.

The difference this time is that policymakers are actively trying to avoid the mistake of letting banks fail. In the early 1930s the Federal Reserve, whose members believed, as some politicians do today, that bank failure was a punishment for bad decisions, allowed thousands of banks to close, a catastrophic development that led to a contraction of the money supply and a general price deflation.

This is what the Fed and the US Treasury are determined to avoid this time. They have already rescued a number of financial institutions deemed to be crucial to the functioning of money markets. It is the primary reason they came up with the $700 billion plan to take bad assets off the balance sheets of banks, so that confidence can return to the financial system and the creditor bank runs will stop. Central banks and governments have moved this week to prop up or nationalise financial institutions in Europe that were also failing.

The problem this time is that although central banks may have learnt their lesson politicians may now be repeating those mistakes. If the US Congress does not correct its failure this week to come to the aid of the banking system, history could repeat itself.

There may be good political and ideological reasons for American politicians to object to the bailout of Wall Street firms that got into trouble through risky and irresponsible investments - just as there was reason to think, back in the 1930s, that reckless banks needed to be purged.

It is easy to see why the words of one congressman this week hold such appeal. “We are now in the golden age of thieves. And where I come from we put thieves in jail, we don’t bail them out,” said Pete Visclosky, an Indiana Democrat, after the fateful vote on Monday.

But it’s an unfortunate paradox of financial systems that while it might be right to punish individuals, punishing the guilty throughout the banking system means much greater pain is borne by everyone.

As Mr Bernanke suggested at that rather austere birthday party, a recession is the inevitable feature of the modern capitalist business cycle. A depression is the unnecessary result of human error by those responsible for safeguarding our prosperity; perhaps understandable in cause, but unpardonable in consequence.

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