Thank God for Gordon Brown. Like an Old Testament prophet, the Prime Minister might have been reviled and lampooned in his own country these past few months, but he is the toast of the world now.

For the first time yesterday financial markets behaved as though they believed the world might actually continue turning tomorrow. The staggeringly comprehensive European financial rescue plan - whose roots can be traced back directly to the emergency room of the Treasury - offers the first real hopes of recovery for a thaw in the frozen financial markets.

The buzz from the weekend meetings of the IMF and G7 finance ministers here in Washington was that it was the British Wot Won It. The plan announced last week to recapitalise leading banks and guarantee the liabilities of most of the banking system was deemed so impressive that it was almost immediately emulated, not only by the Europeans, but by the Americans, too.

It was striking that it was only after the British plan had been announced that Henry Paulson, the US Treasury Secretary, began to recast the $700billion bailout approved by the US Congress so that it, too, would include a large-scale capital injection into American banks.

If imitation by your professional elders is the sincerest form of flattery, then glowing encomiums from a newly minted Nobel Prize-winner must rank as some sort of secular canonisation.

Paul Krugman, the 2008 winner, used his column in The New York Times yesterday, on the day of his academic ennoblement, to lavish praise on the British Government. “What we do know is that Mr Brown and Alistair Darling have defined the character of the worldwide rescue effort, with other wealthy nations playing catch-up,” he wrote.

I suppose if you're feeling slightly curmudgeonly and resistant to the idea of Brown the World Saviour, you might feel inclined to say it was, in fact, the Irish who should get the credit. It was their decision to guarantee all bank deposits that more or less forced the decision on Mr Brown to make his bold move.

But that would be unfair. It took imagination and courage to come up with the British Government's initiative, the sort of qualities that have been noticeably lacking among political leaders around the world in recent weeks. So well done, Gordon.

Of course, now the only question - a fairly important one - is whether or not it will work. Here, it is important to distinguish between the two distinct but interrelated aspects of the continuing crisis.

The first, most pressing task is to get the financial system back to some sort of normality. This is what the British-led rescue has at least a good chance of achieving. The government-led recapitalisation of the banks ought at least to reassure investors and lenders that they are not going to lose their money if they park it in a financial institution for more than 12 hours.

Perhaps more important, the official guarantee of interbank lending ought to remove remaining doubts about the rest of the financial system.

But the second aspect of the problem is probably - if this can be comprehended - even larger now. Even if the panicky stress in the financial system can be gradually overcome in the next few weeks, the bigger problem is that we are in one of those dangerous moments when banks simply don't want to lend to customers.

This is not because they necessarily think they won't get their money back. It is simply because they are beginning a huge process of de-leveraging. That's just a fancy way of saying that they are intent on making themselves a lot smaller.

They are shrinking their assets almost irrespective of the quality of potential borrowers and investors. In the United States today there are proliferating stories about customers with impeccable credit ratings unable to get a loan from a bank to expand a business or build a house.

If we do manage to get the interbank system working again, this is the next challenge: how do you persuade banks to lend in these circumstances?

Government can shore up the capital bases of banks and it can reassure nervous investors that they will get their money out of the financial system, but it cannot force banks to take on risks that they do not want.

If we do not address this problem urgently, we are heading for more misery. Everybody keeps talking optimistically about how stock markets must now be oversold, that valuations are at absurd lows. All that may be true.

There may be money to be made out there, but this stage of the business cycle - the start of a probably nasty recession - is not a time that investors traditionally dive in. They know that the next few years will see some companies collapse completely, even as others survive and prosper, and they don't want to take the chance of betting on the wrong ones.

So the next steps of governments must be to engineer a huge injection of demand into the economy. Banks cannot be forced to lend, but over time they will see money to be made when there is more cash in the pockets of consumers and businesses.

That means more interest rate cuts, but, perhaps more importantly, the mother of all fiscal stimuli. Governments should throw caution to the wind and launch big tax cuts and hefty spending increases.

Get ready for a trillion-dollar US budget deficit. American politicians will be as reluctant to do this as they were to save their banks, but they will get there eventually. They will have Gordon Brown to show them the way again.

gerard.baker@thetimes.co.uk

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