The resulting damage over the past four years has been substantial. The world economy contracted by 6% between 2007 and 2009, later recovering 4%. It is 10% poorer than it would have been, had growth continued at 2007 rates, and the pain is not yet over. Today, we are in the first stages of a second banking crisis.

Economics is in a mess. With the shattering of the dominant Chicago School paradigm, whose rational-expectations hypothesis ruled out, by assumption, the kind of collapse we have just experienced, two old masters, Friedrich von Hayek and John Maynard Keynes, have risen from the dead to renew the battles of the 1930s, equipped this time with explanations for what has gone wrong.

The Hayekian argument is that lax monetary policy made it possible for the commercial banks to lend more money to businesses than the public wanted to save out of its current income. Hence, a whole tranche of investments – ‘malinvestments’, Hayek called them – was being financed by credit creation, not genuine saving. This led to a bubble in the real-estate and financial sectors which powered a consumption boom. When (belatedly) the money tap was turned off, the bubble burst and the American economy slumped. The slump is simply the liquidation of the unsound investments.

By contrast, the problem for Keynesians was not insufficient saving, but insufficient investment. Investment is governed by uncertainty, while saving is a stable fraction of income. Keynes’s economy tips over into recession when, for some reason, profit expectations decline relative to the volume of saving being done. Businesses start to prefer liquidity to investment. This pushes up the rate of interest, or cost of borrowing, just when one would wish it to come down. Saving and investment are then brought back into balance, not by a fall in interest rates, but by a fall in incomes. The recession of 2008–09 was caused by a collapse in investment, not by over-indebtedness; over-indebtedness was a consequence, not a cause.