George W. Bush and his government entered office claiming to be social conservatives. They leave office as conservative socialists – or perhaps as “lemon socialists,” people who socialize only the unprofitable sectors of the economy thus taking the losses onto the public while leaving the profits for the rich – and as the proprietors of the most sudden, large expansion of the state’s role in the American economy since mobilization for World War II.

Claims that they fought for a relative reduction in the size of the American state in the economy were always false: belied by the increase in the federal spending share both during the administration and projected for the future. But in the aftermath of the financial-sector quasi-, partial- and full-nationalizations of this fall, nobody is even daring to make such arguments.

For Republicans, now out of power in the U.S. as a result of the recent election, the future offers a difficult task. Republicans have held the presidency for 20 of the 28 years from 1980 to 2008. Republicans have held control of at least one house of congress for 18 of the 28 years from 1980 to 2008 – and they have held ideological control for more, as often Democratic majorities have been made possible only by conservative Democrats elected from the south. Republicans have run for office on a platform of (1) reducing the size of government, (2) balancing the budget, (3) broadening the tax base, (4) making society more conservative, and (5) using American military force and the threat of military force abroad to make a more secure world.

Yet Republican governments have failed to accomplish any of these. On what platform, then, will Republicans run in the future given that their politicians have no stomach to fulfill any of the campaign promises that they have made in the past? How can the thinkers and activists of the party have an impact on how Republican members of congress (and perhaps presidents) govern? How can they push them toward governing in a constructive yet conservative manner? What ideas and policies could the Republican Party champion to make America a better country and the world a better world? And how could the Republican Party become the carrier of those ideas? These are very hard questions for any political party to resolve, and I wish honorable and pragmatic Republicans success in resolving them.

The problems are more immediate and concrete for the Democratic administration of President-Elect Barack Obama, Vice President-Elect Joseph Biden, Speaker Nancy Pelosi, and Senate Majority Leader Harry Reed. The past year and a quarter has seen the worst American and global financial crisis since the Great Depression. I am now going to stick my neck out and say it will probably turn into the worst American and global downturn since the Great Depression. There appears to be an ongoing collapse in consumer spending in America this fall, which will lead to an enormous inventory buildup this Christmas selling season, and that inventory buildup will then have to be worked off and will depress production in the United States and worldwide for most of next year. Some economists like Paul Krugman are relatively optimistic and expect the rise in American unemployment this recession to fall short of the rise during the Volcker deflation-depression that reached its nadir in 1982. I am not so optimistic.

The coming of what I believe likely to be either the worst recession or the first true depression of the post-World War II era poses problems for a new government, the first and most important of which is that it needs to revise traditional modes of policy thought. As Paul Krugman writes, we are now – and hopefully not for a long time – in “the realm of…depression economics,” in which “virtue becomes vice, caution is risky and prudence is folly.”

Prudent policy requires bold action to stimulate economic demand through lower taxes, greater federal government spending, and substantial aid both to local governments and to distressed communities. This requires, again in Krugman’s words, that the Obama-Biden administration “transcend…conventional prejudices… (and) the fear of red ink.… (Although) fiscal responsibility is a virtue, we’ll need to relearn as soon as this crisis is past…the belief that policy should move cautiously… (and) modesty and prudence…. Under current conditions, however, it’s much better to err on the side of doing too much.”

So far the Obama-Biden administration appears well positioned to meet these challenges. Obama’s designated Chief of Staff Rahm Emmanuel understands that traditional rules of budget balance are suspended for the duration of the downturn – and that a bigger downturn is a reason to be more aggressive in economic policy rather than less. Appropriate numbers are being thrown around in informal conversations about the size of the economic stimulus package. And nobody can say that the U.S. government has not given the idea of market-oriented solutions a fair shot. The current belief that massive government spending is the best solution to the current crisis is the end of a very long road indeed, one that the U.S. has been walking down over the past year and a quarter.

When the financial crisis hit in a sudden squall in August 2007, in the back of the Federal Reserve’s mind was the thought that it should not repeat any of the mistakes that led to the Great Depression. Hence Ben Bernanke and his Federal Reserve were extremely liberal in giving loans to banks and near-banks and non-banks in order to avoid what Milton Friedman said was the key mistake that made the Depression Great: that the Federal Reserve had triggered or allowed a liquidity squeeze that made cash hard to get. Call this Plan A.

In a couple of months it became clear that Plan A was not working. The economy was weakening, and the Federal Reserve remembered the theory – put forward by, among others, J. Bradford DeLong and Lawrence H. Summers – that what made the Depression Great was that businesses began to expect deflation, i.e., falling prices. The expectation of falling prices made every business postpone its investment spending – better to wait a year and build your plant and equipment when prices were cheaper. Thus private investment collapsed. So Ben Bernanke and his Federal Reserve lowered interest rates to what they thought were levels that might trigger inflation. This was their way of making sure that no business anywhere would even begin to suspect that a deflationary spiral was in the making. That was Plan B.

But the economy fell toward, if not into, recession, and interest rates had already been pushed down so low that the Federal Reserve’s monetary policy had lost its virtue and vigor. Time for Plan C: mail out a bunch of extra tax rebate checks hoping that they would stimulate consumer spending, and that once consumers began spending more, the economy would recover with at worst a small recession.

Meanwhile, the investment bank Bear Stearns collapsed. The Federal Reserve and the Treasury concluded that they could not stand by and wait to see if Plan C was working. They had to move to Plan D: case-by-case forced mergers, liquidations, and nationalizations of banks and other financial institutions in order to prevent the course of events that the third theory of the Depression said had made it great.

This theory was Ben Bernanke’s. According to him, the downfall of 1929 to ‘33 was largely the result of ban failures that collapsed businesses’ ability to borrow to expand or even fund ongoing operations. So we had the forced merger of Bear Stearns into JPMorgan Chase, a lull to see if Plan C would work (it didn’t), the renationalization or deprivatization of the mortgage lenders Fannie Mae and Freddie Mac, and that strange weekend when the Federal Reserve bought the insurance company AIG.

Then came the bankruptcy of Lehman Brothers, as Ben Bernanke at the Federal Reserve and Henry Paulson at the Treasury decided that they could not rescue the creditors of every firm on Wall Street. They were wrong.

The failure of Lehman Brothers triggered or uncovered or brought on financial catastrophe – not just in America but in Europe too, where, hitherto, policymakers had been watching with concern and some alarm. It was time for Plan E, the Paulson plan: a US$ 700 billion program by which the Treasury would buy up troubled mortgages, mortgage-backed securities, and derivatives thereof with an eye toward making sure that the banking system recovered so that it could do its job of transferring the savings of Americans to businesses that wanted to hire workers, and so keep the recession a small one and avoid the mistakes that the Bernanke theory said had made the Depression Great.

The hope behind the Paulson plan was supply and demand. Banks and investors want yield, and so are willing to buy risky assets. If the Treasury were to buy US$ 700 billion of risky financial assets and put them on the shelf, this would diminish the supply. When supply falls, prices rise. As the prices of financial assets rose, banks would profit immensely – and people would no longer fear that the bank they were dealing with might dry up and blow away in the next week.

The financial markets swallowed the passage of the Paulson Plan E without a burp, and continued on their downward spiral toward universal financial-sector bankruptcy. By now even Henry Paulson believes that the Paulson plan was ill advised.

So now we are on Plan F. If the prospect of buying up mortgage-backed securities did not boost asset prices and bring banks enough investment profits to create confidence that they were not all going bankrupt next month, governments could invest public money in the banks whether they liked it or not, thus making them so well-capitalized that their failure would be inconceivable.

The Americans left – the Dean Bakers, the Paul Krugmans, the Doug Elmendorfs – had been calling for Plan F for a month. With the failure of Plan E’s passage to move markets, monetary economists from Chicago to Berkeley to Cambridge united in their demand for Plan F. Gordon Brown and Alasdair Darling in Britain led the way, closely followed by the rest of Europe, thus forcing the hand of Henry Paulson, who was ideologically opposed. He had not moved into 1500 Pennsylvania Avenue thinking that he would one day wake up to find himself part-owner of, and living in sin with, a whole harem of banks addicted to derivatives built from mortgage-backed securities.

But now it is clear that Plan F is not working, or is not working well enough, and that this recapitalization of the global banking system with public money is not stopping the slide of the world economy, and is not keeping us in mild recession rather than severe recession or even depression.

So now we move to Plan G, what Paul Krugman calls “depression economics” and what most of us call old-fashioned Keynesian fundamentalist economics: have the government take control of the total volume of demand directly – no longer working at one remove through financial markets.

And if Plan G fails, or does not work well enough? The number of plans in reserve is very small.