I am always reluctant to use the word "unprecedented", but nothing else comes close to describing events last week. The financial sector has changed indelibly - on a global scale. Policy-makers believed we were on the cusp of catastrophe. Their response was swift, substantial and synchronised. Even so, a gloomy economic outlook just got gloomier.

When the markets opened on Monday, investors already knew of the troubles at Lehman Brothers - previously the fourth largest investment bank in the US, and now the largest bankruptcy in US history. Other casualties included Merrill Lynch, which was bought by Bank of America, and our neighbour HBOS, which was bought by Lloyds TSB. Meanwhile, AIG was effectively nationalised.

In less than a week we witnessed consolidation on a scale that would normally take more than a decade.

If the names involved were eye-catching, so were the numbers. In a week when risk aversion was taken to extremes, demand for "safe" assets soared. The yield on US three-month Treasury bills effectively disappeared, falling to 0.03% from 1.49% at the end of the week before last. And the price of gold rose by $55 on Wednesday, to $832 per troy ounce, as a flight to quality took hold. Risk aversion was also evident in equity markets, with the FTSE 100 falling by 3.9% on Monday, only to rise by 8.8% on Friday - the largest increase since 1987.

The equity market revival on Friday reflected a coordinated intervention by central banks, regulators and governments across the G7. In the UK:

• The Bank of England extended the special liquidity scheme (until 30 January 2009). This scheme enables banks and building societies to swap assets that are currently illiquid for UK Treasury Bills. The British central bank also joined with its US, Eurozone, Swiss and Japanese counterparts to announce a collective injection of up to $180 billion to boost liquidity. The BoE "share" of that injection will be $40 billion.
• The Financial Services Authority banned the short selling of financial stocks in the UK. This refers to the practice of betting that shares will fall in price, which has been blamed for the driving down the price of banking stocks.
• The government bypassed competition rules to pass the Lloyds/HBOS deal. The Competition Commission had previously said it was unacceptable for a bank to have more than 25% of the retail banking market.

In the US, Treasury Secretary Hank Paulson announced the creation of a $700 billion fund to remove the illiquid assets that are "choking off the flow of credit that is so vitally important to [the US] economy". The Treasury will use the fund to buy troubled assets from financial institutions, assuming Congress passes the proposals later this week.

The decision to intervene so heavily will not have been taken lightly. In addition to the obvious cost to taxpayers, at a time when public finances are already under pressure, there is the problem of "moral hazard". By preventing an institution from failing, or softening the blow for investors, the authorities might entice them to take greater risks in the future. That may be so but, given the alternative, it is a cost worth bearing. John Kenneth Galbraith once said: "politics... consists of choosing between the disastrous and the unpalatable." So it is with the credit crunch.

Despite the scale of policymakers' intervention, the economic outlook has clearly deteriorated; the financial sector is too important to overall economic activity for this not to be the case. Data releases last week shed further light on the current state of play. In keeping with the downbeat mood, inflation and unemployment are both rising in the UK. The fifth consecutive rise in CPI inflation, to 4.7% in August, led to another letter from the Governor of the Bank of England to the Chancellor. The unemployment rate rose to a two-year high of 5.5%, reflecting a fall in the number of jobs, and an increase in the number of people wanting one.

More encouragingly, retail sales were surprisingly buoyant in August, rising by 1.2% in real terms (3.3% higher than a year ago). We will be taking stock of the macroeconomic context and recent market developments in our forthcoming Global Economic Outlook, to be published later this month.