December is typically the month of conferences in New Delhi, and the global recession did nothing to change the pattern this year. The highlight of the conference season was the one in which two Nobel laureates, Joseph Stiglitz and Edmund Phelps, participated in a conference celebrating the 75th birthday of another Nobel laureate, Amartya Sen. In view of the worldwide economic slowdown, it was not surprising that the theme of the only panel featuring all three Nobel laureates was Globalization and Development. Much of the discussion in this panel focused on how the global economy can extricate itself from the deep hole into which it has sunk. Of course, nothing else seems to be discussed by economists these days, and so it is not surprising that the three Nobel laureates could not really offer any dramatically new remedies.

Indeed, the economic theorist’s cupboard is pretty bare today, seeming to contain just one item: Keynesianism. The global crisis has contributed to a major revival of Keynesianism, which provides the intellectual rationale for the large fiscal stimulus packages announced by all the major industrial economies affected by the current recession. As readers of The Telegraph surely know, Keynes believed that economic depressions are largely caused by a deficiency of aggregate demand in the economy. The Keynesian solution was to attack the problem at its root — increase public expenditure so as to compensate for the reduction in private spending and revive aggregate demand.

Of course, the revival of aggregate demand in the major industrial economies as well as in the large developing economies like China and India is vitally important. If the fiscal stimulus measures fail to reverse the current trend in world output, then that would be catastrophic simply because we do not seem to have any other policy instruments at our disposal. In other words, there is no Plan B. The world economy would then be doomed to a long period of very low levels of economic activity.

But, it is also important to realize that while climbing out of the recession is the most immediate goal of all countries, it is in the ultimate analysis a short-term objective. In the long run, economists and policymakers must work together in order to establish a new set of international rules and regulations, which will ensure that worldwide recessions of the kind witnessed today do not occur in the future. Of course, this is easier said than done because economists are in completely uncharted waters. They have never had to contend with recessions in a globalized world where economies of individual countries are intricately connected with one another.

This is unfortunate because the history of economics suggests that the subject typically reacts to new phenomena after the event. In other words, economists are often a step behind when confronted with new kinds of major crises. For instance, much of the advances in current macroeconomics have been concerned with correcting imbalances in individual countries. Countercyclical policies have indeed been successful in averting major business cycles until the onset of globalization. But what kinds of reform should we advocate now?

As I wrote in an earlier column, a globalized world needs global solutions — that is, the reforms must be adopted by all the major countries. Of course, this must inevitably imply some loss of national sovereignty. Fortunately, groups of countries have in the past willingly given up some degree of national sovereignty in the pursuit of common goals. The most prominent current example of this is provided by the countries in the European Union who can no longer follow independent monetary policies.

The financial crisis has demonstrated in no uncertain terms that unfettered financial markets are an unmitigated disaster. So, perhaps the first order of business is to set up an international regulatory authority, which will supervise and regulate the functioning of financial markets all over the world. This idea may sound far-fetched, but something like this has actually been proposed by the British prime minister, Gordon Brown, immediately after the onset of the financial crisis. This global regulatory body must be able to set borrowing and lending norms, which would then become mandatory for all ‘member countries’. Of course, such an authority must also be armed with the powers to impose sanctions on countries where these norms are flouted. Notice that the presence of such a body would have prevented the American sub-prime mortgage crisis, one of the major contributory factors of the recession.

Another important issue is the construction of a process that will ensure that countries cannot run up huge persistent deficits on their external account. Unless this is done, there will be an imbalance in global demand. There is a sense in which the United States of America has been living beyond its means. For many years running, its exports have been much smaller than its imports. A persistent trade deficit in most other countries would have brought into play some correction mechanism that would have prevented the growing imbalance between exports and imports. However, countries like China — which have huge trade surpluses, in essence — have acted as “creditors” to the US by investing large sums in US treasury bills. What would have happened if China had not invested in these treasury bills? Perhaps, this would have caused Americans to suddenly tighten their belts, thereby delivering a body blow to export industries in several countries.

These systems will not develop overnight. Certainly, initial attempts to develop such schemes will be far from perfect. In fact, pessimists may question whether the processes will even get off the ground because these will involve very major changes in the international economic order, and so very determined opposition from vested interests. One far-reaching change may be in the status of the US dollar as ‘the’ global currency, the numeraire against which all currencies and commodities are measured. Notice, for instance, that the price of crude oil is always quoted as so many dollars per barrel. If the dollar loses this privileged status, then its external value will probably depreciate by a large amount — something that the US may try to prevent.

Of course, one option is to forsake all attempts at reform and give up globalization instead. Moves in this direction are clearly discernible since some countries have tried to adopt the protectionist route by raising import duties. However, one of the abiding truths of economics is that the world as a whole can only be worse off if each country tries to protect its own domestic industries. The intellectual, and perhaps more importantly pragmatic, challenge is to devise cooperative measures that benefit all countries.