The United States has changed the rules of economic management in the past few weeks.
This has enormous implications for the rest of the world.
Parallels have been drawn between the current financial crisis and the Great Depression of the 1930s, but a key difference is the policy responses of the US Federal Reserve and Government.
This is unsurprising given that Ben Bernanke, governor of the Federal Reserve, is an academic who has studied the causes of the Great Depression.
The Depression and the current crisis were the result of shoddy lending practices by financial institutions operating in largely deregulated financial markets.
Following the Wall Street Crash in 1929, the money supply in the United States plummeted, as bank after bank collapsed due to a loss of investor confidence.
Milton Friedman, in his text A Monetary History of the United States, sought to prove that the Depression could have been avoided if the Federal Reserve had maintained the money supply during this period rather than allowing it to shrivel.
In the current situation, Mr Bernanke has followed Mr Friedman's prescription by flooding the markets with liquidity.
He has lowered the discount rate in the US, meaning banks can access funds from the Federal Reserve if they run short.
What this means is that the US is attempting to inflate its way out of the current credit crisis.
Inflation reduces the real value of debt.
The cost is borne by the lenders who receive their money back with less purchasing power.
A significant portion of US debt is held by foreign investors, particularly the Chinese.
The US Government has also sought to relieve financial institutions of their most toxic bad debts using tax payers' money.
So much for the efficiency of free markets, particularly in the financial sector.
Many of the regulations that controlled bank lending until the 1980s dated from the Great Depression.
These rules, restricting lending practices such as the Glass Steagall Act (1933-99), were removed over the last few decades as the free market mantra prevailed.
This has contributed to the current meltdown.
US authorities are faced with Hobson's choice.
Either allow numerous financial institutions to fold, and risk a deflationary spiral, as in the 1930s; or flood the financial markets with liquidity, and relieve imprudent lenders of their most risky loans in a massive bail-out.
The authorities have chosen the latter course of action.
Pumping dollars into the US economy will be inflationary.
The extent of the inflation will depend on the willingness of other countries to continue accepting US dollars for their goods and services.
It will increase the size of the US account deficit, as many of these dollars are spent on foreign goods.
It will also drive down the value of the US dollar.
In other words, it will increase the value of the kiwi.
This is already happening, just as our Reserve Bank seeks to stimulate our economy by cutting interest rates and the value of the New Zealand dollar.
The actions of US authorities have effectively negated recent attempts by our Reserve Bank to stimulate our stagnant economy.
Herein lies the conundrum for New Zealand.
Over the last few decades, we have sought to run our economy according to conventional economic wisdom.
We have adopted stringent inflation targeting as macro economic policy number one.
We are continuing to play by the rules in the current environment, when many other countries have abandoned the rule book to avoid a severe downturn.
Unless we are astute in our economic management from here, we risk making things very unpleasant for ourselves.
A purist approach in applying textbook rules could be very costly.
During the Depression, many countries devalued their currencies and introduced protectionism.
Before the Depression, most currencies were fixed against the gold standard.
In devaluing their currencies, each country sought to gain a competitive advantage for their own producers.
As all countries devalued, this ended up having little effect.
Countries also introduced protectionism in an attempt to assist local producers and reduce job losses.
These policies became known as "beggar thy neighbour", because all countries lost out as world trade plummeted.
The effect of the fall in trade was to worsen the length and severity of the Depression.
Fortunately, the world economy is not at this stage yet.
That is why, so far, this has been a financial crisis rather than an economic crisis.
In the current situation, there are yet to be calls for protectionism, but this may be a matter of time, depending on the length and severity of the downturn.
The current US inflationary policies mean that its exporters are given an advantage on world markets as their currency falls, as are Chinese exporters whose currency is fixed against the US.
The scenario for New Zealand is that as other countries abandon inflation targeting in order to avoid a financial meltdown, their currencies depreciate, making their exports more competitive.
This makes it harder for our industries to compete, adding to the downturn here.
As job loses mount, and our housing market slumps, people feel less wealthy and reduce spending.
This creates a vicious cycle.
House prices fall, leading to less confidence and spending, leading to further job losses.
Our mountain of private debt will act as an millstone around our necks, particularly as asset prices fall.
Over the past weeks, the rules of economic management have changed.
The US is trying to inflate its way out of its credit crisis.
This crisis is the result of shoddy lending practices, due to the removal of many rules put in place following the Great Depression.
If New Zealand continues to play by the rules, in applying strict inflation targeting in this environment, we risk falling into the deflationary trap which other countries are seeking to avoid.
Our export sector will continue to be shredded.
Our debt mountain will drag us down in a viscous cycle of job losses, falling house prices and huge debt repayments.
Peter Lyons teaches economics at St Peters College in Epsom, and has authored several economics texts.
