Tony Blair once said that ‘we’re at our best when at our boldest’. Gordon Brown is – finally – heeding that advice. His plan to shore up Britain’s banking system is our best hope of pacifying the financial panic, getting credit flowing through the economy again and avoiding a 1930s-style depression. No wonder it is being copied across the world.

The need for massive state intervention in the banking system is regrettable. But exceptional times call for exceptional measures. Britain – and the world – is suffering a full-on financial heart attack. Unless the financial arteries of the economy are unclogged soon, huge job losses, bankruptcies, repossessions and a sharp fall in living standards beckon.

The government must do whatever it takes – including, if necessary, fully nationalising Britain’s banks for a while – to rescue the economy from financial oblivion. Once the immediate crisis has passed, better and tougher financial regulation should be a priority. But while the glaring failings of global finance clearly need fixing, should the rest of the economic rulebook be torn up too?

Many on the left think so. Ken Livingstone, the Guardian’s Seumas Milne and others argue that the government should turn its back on market economics. Since capitalism seems to be collapsing under the weight of its internal contradictions, they believe, the government should finish it off and regulate left, right and centre. More measured voices, such as the TUC’s Brendan Barber, favour a ragbag of measures such as curbs on boardroom salaries and a new industrial policy.

But the priority now is tackling the crisis and averting a depression; everything else is a dangerous diversion. If struggling businesses that have just had their overdraft cut fear that they are about to be clobbered with higher taxes and more red tape, investment and jobs will suffer. The last thing a heart attack victim needs is to have a healthy leg amputated.

The government’s bank rescue plan needs to be accompanied by measures to support the economy, not shackle it. The Bank of England should continue to cut interest rates, soon. Even though inflation is well above the target rate of two per cent, it is set to fall sharply as oil prices tank. Collapsing demand means that the real threat now is deflation, not inflation.

Some argue that the Bank of England’s independence should be compromised. But that would be a mistake. Even the perception of political meddling in setting interest rates would add to financial uncertainty, undermine the credibility of monetary policy and raise the cost of government borrowing. As we learnt to our cost in the 1970s and the late 1980s, letting inflation rip does not lead to a sustained improvement in unemployment and economic growth; quite the reverse.

But once the crisis has passed, the government should reform the setting of monetary policy. The Bank of England’s target measure of inflation should be amended to include housing costs. Its mandate should also be broadened so that it takes more account of asset prices. This would allow the Bank to raise interest rates to prevent bubbles getting out of hand – and thus avert future busts.

Faced with the threat of a depression, the government must not be hamstrung by its fiscal rules. Rightly, the government plans to borrow huge sums to finance the rescue of the banking system. It is well placed to do so since government debt as a share of GDP is low. This need not increase the national debt in the long term: Sweden’s government turned a profit on its investment when it rescued its banks in the early 1990s. The government must also be ready to boost demand with tax cuts and spending increases if the recession turns really nasty. Fiscal tightening will certainly be needed – but only once the economy is recovering.

The bigger question, though, is whether, once the immediate crisis has passed, economic policy in areas other than finance needs to be revised. Leftwing populists have been quick to bury what they describe as the era of ‘unfettered markets’, but an economy where the government takes around 40 per cent of national income in tax, pays for and provides essential services such as healthcare and education, and regulates everything from employment rights to credit-card contracts, can scarcely be described as one where the state has shrivelled and markets have free rein. So the issue is not whether the financial crisis sounds the death-knell for the free market, but whether it tips the balance towards greater state intervention.

That question is in fact two: first, does the crisis in financial markets suggest that competitive markets more generally do not work as well as we previously thought?; and second, will the crisis shift public opinion towards supporting a bigger role for the state? My answer to the first question is no; and while the answer to the second question is still unclear, people do not appear to be hankering to turn the clock back to the 1970s – notwithstanding the success of the TV series Life on Mars.

As I wrote in 2002 in my first book, Open World: The Truth about Globalisation: ‘Financial markets are unlike other markets. They are inherently unstable. They are prone to Manias, Panics, and Crashes … Why? Because they involve bets on an unknown and unknowable future.’ Product markets are very different: the market for cars or baked beans is not prone to destabilising speculation – and even if people did start gambling on the price of baked beans, its impact on jobs and the economy would be limited. The temporary part-nationalisation of Britain’s banks does not call for increased intervention elsewhere. Royal Bank of Scotland may have come unstuck, but Tesco continues to deliver the goods.

Faced with a nasty recession partly caused by reckless lending in the US, the temptation to blame outsiders for our woes will grow. But we shouldn’t throw the baby out with the bathwater. Britain benefits hugely from its openness to foreign products, ideas and people. The low prices in ASDA and Primark are only possible thanks to free trade, and commerce with China will provide many of the jobs of the future. Recent migrants from eastern Europe have filled vital jobs and revitalised the economy through their dynamism. Beggar-thy-neighbour protectionism made the Great Depression much worse; we would be crazy to repeat the same mistake.

Britain’s flexible labour markets will be a key strength in the tough times ahead. They allow the economy to adapt rapidly to change, helping to redeploy workers from shrinking industries to growing ones and keeping unemployment down. Combined with measures to make work pay, help people find jobs, and equip them with the skills they need, New Labour’s labour-market policies stand us in good stead. We should not be trying to protect yesterday’s jobs at the expense of tomorrow’s.

While tax rises will probably be needed in the medium term to pay for the costs of the crisis and an unexpectedly deep recession, support for higher taxes is hardly likely to be an election winner. Taxes must also remain low enough to support opportunity and enterprise. If working hard and starting a business is not rewarding enough, economic growth will suffer – and with it the ability to invest in public services. And unless public services continue to be reformed, with choice driving up standards and giving people what they want, voters are likely to feel their money is being wasted.

With Labour so far behind in the polls, the only chance of recovery depends on rescuing the economy from the worst crisis since the 1930s. Brown has come into his own in the past month, while the Conservatives, who are unconvincing critics of City practices, are flailing. But lurching to the left in the mistaken belief that markets no longer work and that voters are crying out for bigger government would be a huge mistake.