The Bank of England has kept interest rates on hold this month. This is in the face of mixed signals about where the economy is heading.

Inflation has remained steady at 2.1%. But prices for food and fuel have been rising, and there is concern that this might stoke up some inflationary pressure. At the same time, the housing market has slowed considerably, and important trading partners (including the United States) appear to be heading for recession.

In normal times, monetary policy (conducted primarily through the central bank adjusting the interest rate) can be used to regulate the economy, and it does a pretty good job. When the economy is overheating, inflation is a threat and unemployment is low - and an interest rate hike can serve to reduce demand thereby curtailing inflation. Likewise, an interest rate cut helps to stimulate demand when unemployment threatens.

The problem we have now is that we are not in normal times. Both inflation and unemployment are viewed as threats on the horizon.

Which way then for the interest rate? I would argue that it should come down in order to protect the economy from recession. There are hazards in this - most obviously, cutting the interest rate could fuel inflation at a time when prices are rising anyway. But the price rises that we have seen are one-shot increases due to specific factors - so long as wages are kept under control, there is no reason for these to generate a sustained increase in inflation.

The prime minister has, this week, stressed the need to keep public sector pay settlements down. This does not signal a return to the ill-fated incomes policies of the 1970s, but it does operate on people's expectations. The chances of a wage-price spiral occurring are much reduced if people do not expect large wage hikes.

To sum up, the direction of change for the interest rate should still be downward - though this month the Bank of England is probably right to wait, if only to ensure that the government's warnings on pay settlements are heard over the coming period.

Chancellor of the Exchequer, Alistair Darling, has announced new powers for the UK's Financial Services Authority (FSA). These come in the wake of the UK's first bank run for over 100 years - the now infamous case of Northern Rock. The new powers will allow the FSA to protect customers' cash if a bank gets into financial difficulties, hence giving customers priority over banks' other creditors. The FSA will also have new powers (and duties) to ensure that banks in difficulties do not suffer cash flow problems.

The new powers will become part of legislation to be passed in May of this year, following a consultation period. Broadly they are to be welcomed. There are some gaps that need to be plugged, however. Currently, responsibility for the security of the banking system is shared between the FSA, the Bank of England, and the Treasury (headed by the Chancellor of the Exchequer). That nebulosity of responsibility did not facilitate decision making in the face of Northern Rock. The new legislation needs to make very clear exactly who is responsible for what, and how the three bodies should work together. Mr Darling's preferred model is one in which the FSA and Bank of England have input, but where the final responsibility is the Chancellor's. This is a good model in that someone has clear responsibility. What needs to be worked out, though, is the nature of the input of the other two bodies - they each have information and the institutions need to be in place to ensure that each is heard.

Can migrants bail us out if the economy goes pear-shaped? It is often argued, and rightly so, that migration has been a big benefit to the British economy in recent years. The influx of workers from eastern Europe has allowed the economy to grow, while keeping inflation at low levels.

With the possibility of a recession on the horizon - or a serious downturn at least - the question needs to be asked: can this process work in reverse? One possible outcome would be for migrant workers to respond to the downturn by moving away from the country. If they are made unemployed, perhaps they will do so in their search for work elsewhere. This would mean that the downturn need not be accompanied by a surge in unemployment. That would be good news indeed.

There is, however, another possibility. Almost 40 years ago, John Harris and Michael Todaro wrote about the response of migrants to unemployment in the context of rural to urban migration in developing economies. They argued that migrants might stay in the cities even in the face of unemployment, because they are compensated for the higher probability of unemployment by higher wages when in work. A Harris-Todaro mechanism could reduce the amount of return migration during a recession in the UK, and could scupper hopes for an unemployment-free downturn.

How things will pan out is really a matter of speculation. We don't know that there will be a serious downturn - although that looks increasingly likely. And we don't know what decisions migrant workers would make if a downturn came to pass. One thing we do know - there is something here for policy makers to chew over.

Mercifully, the Bank of England's Monetary Policy Committee has decided to cut interest rates this month, from 5.75% to 5.5%. The question is: is a quarter point cut enough?

Some commentators have suggested that, with the recent increase in fuel prices, inflation remains a problem. This will have acted as a restraining influence on the MPC in making its decision to cut interest rates. I remain of the view, however, that fuel prices are blipping - indeed the price of oil has already fallen well over 10% from its peak, although this has yet to feed through into reduced prices at the petrol pump. The threat of wage inflation that briefly appeared earlier in the year went as fast as it came - and in any event it seems to have been driven by a small number of settlements in atypical firms.

As I have mentioned earlier on this blog, the real issue for the macroeconomy now is how resilient the US economy will prove to be to the threat of recession. The leading indicators strongly suggest that a downturn is on the way. This being so, the MPC has clearly moved interest rates in the right direction. Has it cut them enough? I don't think so. Expect more cuts early in the new year.

Will there be an interest rate cut in December? The economy is faltering, with retail sales and manufacturing output both sluggish - yet the interest rate hikes from earlier in the year have yet to take full effect in slowing things down. Meanwhile, the slump in housing starts in the US is little short of catastrophic, and downturns in this series traditionally herald recession; and we all know that when the US sneezes it takes little time for the the UK to catch a cold.

On the other side, there are concerns that escalating oil prices fuel inflation. But the currently high price of oil is, as I have argued earlier on this blog, likely to be a blip.

The Monetary Policy Committee should not wait longer before cutting rates, and arguably should do so by more than a quarter of a point this month.

You don't need 20-20 vision to have seen how much more expensive it has become to fill your car with fuel in the last few weeks. Diesel has already topped the £1 per litre mark, and unleaded petrol is not lagging far behind.

The cause is a jump in oil prices. Oil is now trading at $89 per barrel, and some observers think that the $100 barrel is not far away. The immediate cause is tension between Turkey and the Kurdish population in northern Iraq - there is a fear that this might escalate to fighting that would disrupt supplies. Speculators are buying up oil with a view to selling it on once the price has risen further. This in itself is pushing the price up - both because such speculation increases demand and reduces supply to the end user.

Long term the price of oil will rise. The increased demand from rapidly developing countries, and the diminishing pool of easily accessed oil both serve to ensure that. But speculative blips happen along the way which cause fluctuations (down as well as up) of the price of petrol at the pump. What we have here bears all the characteristics of such a blip.

The news of a further sharp drop in housing starts in the US must surely fuel fears that a more general economic downturn is on the cards in that country. The work of Leamer (which I have referred to in an earlier post on this blog) links recessions firmly with the state of the housing market - and in particular with residential investment.

The Fed cut the headline interest rates in the US by half a percentage point last month. That is a sharp drop in one go. But it would appear that such a policy is needed to kick-start the economy before it swings into a full-blooded recession.

Michael Greenstone has recently released the results of a study into the effects of the Surge policy in Iraq. Based upon data from the world's financial markets, in particular on the price at which bonds issued by the Iraqi state are traded, he concludes that the Surge has been unsuccessful. To be specific, people are making their investment decisions as if the probability of Iraq defaulting on these bonds has risen by some 40%. This suggests that, far from improving security and stability, the Surge has made Iraq less stable.

The Surge has, however, improved various indicators of security within Iraq. This provides a puzzle - why is there a discrepancy in the results. One possibility is that the indicator based on bond prices is more comprehensive in that it captures a measure of overall confidence in Iraq. Another possibility is that this measure is based on the assessment of people who, for the most part, have no direct experience of Iraq, and whose information may be flawed.

While Greenstone's work provides an intriguing measure, therefore, the jury has still to be out on whether the Surge has been a success.

Edward Leamer has recently produced work on the link between housing and the business cycle. He makes a compelling case in arguing that residential investment is an important leading indicator - and that looking at changes of residential investment over time can provide early warning of turns in the business cycle.

His analysis suggests that the US is heading for a recession. The recent interest rate cuts introduced by the Fed suggest that the policy response is already under way.

We all know that when America sneezes, the rest of the world catches a cold. The signs are that the next 18 months or so may prove to be a bumpy ride.

Banks are funny businesses. They receive our deposits and then take a calculated risk by lending out some of this money to other people. By charging borrowers more interest than they pay lenders, they make a profit. Usually things work just fine, by that element of risk is always there. What if depositors all ask for their money back at once? Again, usually, things work out fine. If this happens, the bank has to borrow from other banks. So long as its assets (the loans it has made to borrowers) are sound, there should be no problem in doing this. Sometimes, though, confidence can be a fragile thing. This is just what has been demonstrated in recent days by the story of Northern Rock.

Northern Rock has sound assets - mortgages that can be expected to be repaid. Its recent history is, in this respect, a little puzzling. But it is indicative of an underlying lack of confidence that is giving the whole financial system the jitters at present. Lower interest rates would help steady nerves. But, under the present system, interest rates are not set with that in mind. Legislating for a minimum amount of banks' assets to be held in liquid form (as cash, for example) might also help, though this presumes that the authorities know better than the banks themselves what is good for the latters' business. Such required reserve ratios do, however, exist in several countries. Giving savers a guarantee that their savings are safe is another solution that can prevent a run on banks - but it would not encourage prudent behaviour by the banks.

There are no simple cures for the jitters, therefore. But there is some consolation in knowing that the reason for that is, in part at least, because there is no obvious cause either.

The Taxpayers' Alliance suggests that environmental taxes in the UK have gone too far. The group argues that the tax take is greater than the cost of the environmental damage caused by pollution. This misses the point.

The taxes are not there to raise money. They are there to raise the relative price, and so reduce the consumption, of things that lead to pollution. There may be legitimate concern that green taxes are being used as a type of stealth tax - a sneaky way to increase the overall tax burden. But that is not a problem that should necessarily be fixed by reducing environmental taxes - if, as seems to be the case, such taxes are effective in tackling pollution, a better solution would be to reduce the burden of conventional taxes, such as income tax of VAT.

Zimbabwe's inflation rate has hit a staggering 7600%. The International Monetary Fund has suggested that it may rise further over the coming months, possibly to as much as 100000%. German economic students will be pleased - it means that their lecturers will at last stop using their country's experience after the first world was as an example of hyperinflation.

Robert Mugabe, president of Zimbabwe, has frozen prices and wages in an attempt to curb the inflation. Price and wage controls have been used before, of course, including in the UK during the 1970s. They work too, but experience suggests that their beneficial impact is short-lived. This is because they do not tackle the fundamental cause of inflation. As Milton Friedman so memorably said: 'Inflation is always and everywhere a monetary phenomenon.'

The flip side of rising prices is the falling value of money. Money falls in value because the stock of money in circulation is rising. The fix for inflation is to curb this increase in the money stock. In practice that means hiking interest rates so that people prefer to hold their assets in an interest bearing form - that is, they trade their money for interest-bearing assets.

The overnight interest rate in Zimbabwe is currently 600%. That may sound high, but it is dwarfed by the rate of price increase, so the real rate of interest is negative. People take out loans, knowing that in real terms they will pay back (a lot) less than they have borrowed. This fuels demand, and prices skyrocket.

Drastic times call for drastic measures. A credible stance against this hyperinflation probably means a new currency, one that is linked to a stable international currency, and the adoption of a really tough interest rate policy. To the extent that credibility is linked with people, it means new people too.

Share prices are tumbling. The root cause appears to be concern over defaults on loans in the USA, specifically in the sub-prime lending market. The sub-prime market offers mortgage loans to people who might not be able to get loans from mainstream lenders - in other words, high risk borrowers. As American interest rates have risen, so the default rate on these loans has increased.

The extent of these defaults is currently only being guessed at, with estimates up to several hundred billion dollars. Obviously this is a huge amount, and it is easy to see why investors have become jittery. Nevertheless, sub-prime lenders insure themselves to some degree against default by charging higher interest rates than the norm. A high rate of default in this market is par for the course. This is not to minimise the potential seriousness of the current situation. But it is likely that many investors are pulling their money out of the equity markets on the basis of fears of a worst case scenario. Eventually the market will bottom out, and the likelihood is that there will be some bounce-back - a re-adjustment back up to bring prices in line with the real (rather than the feared) situation. Just when it will bottom out, and how substantial the bounce-back will be remains unclear at this point.

Nobel prizewinning economist, Robert Fogel, has recently produced a paper that makes alarming predictions for those of us living in Western Europe. He identifies 6 main economic regions in the world - the USA, the EU (prior to accession of the 12 new members), India, China, Japan, and a group of 6 SE Asian 'tigers'. In the year 2000, the EU lagged only slightly behind the USA as the region with the highest gross domestic product. By the year 2040, Fogel expects the USA's GDP to have quadrupled in size. But China's GDP by then will be three times that of the USA. India's will be roughly the same as the USA's. The EU's GDP, meanwhile, will have fallen to little more than a third of that of the USA.

In terms of per capita figures, Fogel expects the average person in China to have more than twice as much income as the average person in the (pre-accession) EU by the year 2040.

These figures imply an alarming stagnation in Western Europe. There are two reasons for this. First, Fogel expects growth per capita in Europe to be slow (just 1.2% per year in real terms - less than a third of that assumed for the USA, and one seventh of that assumed for China). Secondly, he expects population to be stagnant in Western Europe. He explains his low assumption of per capita growth by reference to the demographic time bomb - the rapid ageing of the population in some countries means that much resource will need to go towards supporting the retired (consumption expenditure) rather than investment. It is true that this might put a brake on growth in some European countries - notably Italy and Germany - but by no means all. Meanwhile, Fogel's prediction of stagnant population growth in Western Europe has already been debunked. Migration is taking care of that.

Moreover, the assumption that China can continue to grow at over 8% per year over a further period of more than 30 years is a strong one. At some stage, such rapid growth is likely to lead to inflation - the symptom of an overheated economy. Given the uneven nature of growth in China - with a highly developed seaboard and a western interior that remains poor - such overheating is likely sooner rather than later, and this will inevitably constrain the potential of that huge economy to maintain its current growth performance.

The Fogel figures seem to exaggerate the challenge faced by Europe, but this does not mean that there is no challenge. The world's most rapidly developing economies are growing partly because they are catching up with the world's richest. But partly also they are growing because the rewards to initiative, invention and enterprise are huge. Therein lies a lesson.

Things are not going well in the European Union summit. The story is that Nikolas Sarkozy, the new French president, has insisted that the commitment to 'free and undistorted competition' be watered down; it appears that this commitment may be replaced by one that aims at a 'social market economy aiming at full employment'.

Tony Blair, reaching the end of his tenure as the British prime minister, has issues of his own - he wishes to safeguard the UK's law-making and foreign policy powers. But these matters should not distract him from the need to focus also on the free market issue.

Full employment is a phrase that sounds as though it should be easy to understand - but it isn't. There are many people who choose not to work, for a variety of (usually very worthy) reasons. Full employment does not, presumably, mean that no-one is allowed to be a student, to look after children or elderly relatives, or to retire. At any time, there will also be some people who are between jobs; in many cases they can search more effectively for new employment while they are unemployed. So there will always be some unemployment. Working definitions of 'full employment' acknowledge this. What 'full employment' means, therefore, is low unemployment - a rather vague concept.

Now one way of achieving the goal of low unemployment is for the government to provide plenty of financial support to industry. In this way, when trade slumps, the threat of mass redundancies can be averted. If trade in a particular sector is set to bounce back up after a short term slump, this might indeed not be an altogether bad policy to implement - though of course it would be better if firms were managed in such a way as to weather such transient storms themselves.

The problems come when government provides substantial long term support to businesses that would otherwise be ailing. We saw plenty of this in the UK in the 1970s. The coal, steel, air travel, and car manufacturing industries hit troubled times and were bailed out by government (that is, taxpayers') money. But the tide had turned - other countries could by then produce these things more efficiently than we could in the UK. Ultimately the power of the market won out, the state support ended, the UK industries suffered, and unemployment shot up.

Providing financial support to industry is a natural thing for governments to want to do. It can alleviate unemployment - at least until the next election. It can provide short term relief for some severe social problems. But - and here's the nub - it cannot do so indefinitely. Ultimately, market pressures will win out. When they do, as they did in early '80s Britain, the bump is all the more painful.

'Free and undistorted competition' is a means to an end. 'Full employment' is an end in itself. While competition is sometimes difficult for politicians to stomach, in the long run it serves the goal of low unemployment rather well. It should not be sacrificed on the altar of a European fudge.

In the European context, free competition also means the application of strict anti-trust regulation. This protects us all from the abuse of monopoly power - the tendency for firms that are dominant in their industry to set high prices (because there are few alternatives available to their customers), and to produce at a scale of operation that is not the most efficient. Curbing the power of monopolies would seem to be an altogether desirable thing.

President Sarkozy came to power on a reforming agenda that led many commentators to draw comparisons with Margaret Thatcher. Her regime was characterised by a pretty poor record on the macroeconomy, but also by some excellent microeconomic policies which still provide benefits today - these include the promotion of competition. If the comparisons are to continue, President Sarkozy has an awful lot to learn.

The beleaguered president of the World Bank, Paul Wolfowitz, is to resign following allegations that he arranged preferential employment terms for his partner. In a deal reached to secure his resignation, the board of directors of the bank have announced that they accept that he acted 'ethically and in good faith'.

Corruption is undoubtedly a major cause of economic hardship in many countries in which the World Bank is engaged. The head of the organisation not only has to be squeaky clean in order to be effective in combatting such corruption - he or she has to be seen to be squeaky clean. Mr Wolfowitz may have been caught up in a labyrinth of World Bank regulations, he may have suffered by receiving ambiguous advice, and he may have done what he thought was right at the time. None of that matters. His moral authority to lead an organisation that is battling against corruption evaporated, and so he had to go.

The Foundation for the Economics of Sustainability proposes an innovative cap-and-share scheme to reduce CO2 pollution. It works like this. The government sets an overall target for emissions, and allocates certificates to each adult in the country based on their share of these emissions. They can then take these to the bank (or presumably to somewhere like eBay) and sell them at the market rate. Firms that introduce polluting goods (that is, the producers or importers of coal, gas etc.) must then buy enough certificates from the bank (eBay, wherever) to cover their output, and their behaviour will be audited by government inspectors. Since these producers must pay for certificates, the cost of these certificates will be embedded in the costs of the polluters that use the coal, gas or whatever.

In many respects this is a similar scheme to existing emissions trading schemes. One difference is that the permits are allocated first to individuals, not to firms. Another is that it is the producers rather than the users of the polluting agents that pay - though of course they shift the incidence of this payment on to the users.

A neat feature of the proposal is that consumers are automatically compensated for higher energy prices. They receive payment for selling certificates. In terms of basic economics, there are two counterbalancing effects - an income effect and a substitution effect. Consumers' income rises (making them better off), and the price of energy increases (making them worse off). But because the relative price of energy rises (energy prices are higher but other prices stay the same), it is likely that less energy will be demanded.

Another neat feature is that the scheme introduces a limit to supply (like rationing), but does not impose the disbenefits of rationing on any individual. Individuals can consume what they want to consume, firms can produce what they want to produce - they might just have to pay a bit more to do so if it involves pollution. But the freedom to choose is preserved.

An intriguing feature of the scheme is the implication for secondary markets. If, at the end of a year, there is a shortage of certificates, petrol and other energy prices will rise. So there is likely to emerge a futures market for consumer purchases of fuel, as consumers try to insure themselves against such price hikes. What form this would take is the subject of fascinating speculation.

Are there any clear disadvantages? Sure. Compared with existing schemes, it will be bureaucratic. Relatively few firms are covered by emissions permit schemes; allocating certificates to 60 million individuals in the UK would necessarily be costly, given the need to ensure that the scheme is not compromised by forgery and other corruption.

So overall my judgement would be that this is an idea that has promise - but also it is one that requires more development before it is ready to be put into action. In particular, the benefit of allocating the certificates to individuals rather than to companies needs to be quite considerable in order to offset the likely costs.

Interest rates have risen again in the UK, to 5.5%. In view of the latest figures on inflation, this is quite modest, and one might have thought an increase to 5.75% would be more likely to provide the short sharp shock needed to bring down expectations of inflation. Perhaps the Monetary Policy Committee is hoping that today's will be the last increase needed. That would certainly be a favourable outcome - but it is one that relies on a measure of restraint on the part of wage negotiators.

Energy Watch is calling for discounts to be offered by electricity and gas companies to poorer households. The sentiment behind the call is laudable, of course. Whether this is the best way to achieve the social objectives that underpin the organisation's concern is, however, altogether another matter.

As a result of collecting data for tax purposes, the government is in a unique position to know which households are relatively well off and which require support. Power companies do not have this information, and are not in a position to collect it.

Moreover - and this is the key point - it is not at all clear that poorer households, if they are to be helped in some way, should be helped by cutting energy prices. For doing so distorts the signals that the price mechanism is designed to give. It artificially reduces the price of energy in relation to that of other goods, and that artificially boosts the amount of energy demanded. Such an artificial distortion is not desirable in its own right because it corrupts the allocation of resources in the economy. What's more, it is not a very environmentally friendly solution.

A much better solution exists. That is to give such households an income supplement through the tax or benefit system - then they can choose how they spend the extra resource.

The annual rate of price inflation has risen to 3.1%, and wages are rising at well over 4% per year. These statistics, released this week, suggest that another interest rate hike may well be on the cards. This is in spite of unemployment figures that confirm an increase in the rate of joblessness.

Meanwhile the exchange rate has moved to strengthen the pound against the dollar, with £1 now being worth more than $2 for the first time in many years. This reflects a flow of capital into the UK as investors anticipate that higher interest rates are on the way.

The good news is that the strengthening pound will reinforce the effect of higher interest rates in dampening inflation.

Gordon Brown has given what is probably his last budget speech, and it is in many ways a typical politically astute Brown budget.

The basic rate of income tax is to fall to 20% (though this will almost all be offset by scrapping the bottom rate of 10%). This is a headline grabbing move, but it should not disguise the fact that, while the budget appears to be very mildly expansionary over the coming year, it has implications that are more deflationary over the medium term. The changes to road tax and to the treatment of empty properties, due to kick in during the 2008-09 financial year, will raise the tax take quite significantly. To the extent that people see the higher taxes coming, and start saving now in order to pay them later, the budget should help take some of the heat out of the UK economy.

There are numerous green twiddles - taxing gas guzzlers more, taxing fuel-efficient cars less, scrapping stamp duty on new carbon-neutral houses etc. These capture both the spirit of the times and the ground of Brown's political opponents.

There is more money for education. Good. Education is an investment. But the government's experience in giving money for health without adequate conditions should provide it with a lesson. There is still a lot of work to be done in reforming our education system.

Over the longer period, Mr Brown has succeeded - despite some scares along the way - in satisfying his own 'golden rule': that on average over the business cycle the government should achieve a surplus on its current budget. He's taxed and spent: that has implications for efficiency at the microeconomic level that may represent chickens that have yet to come to roost. But as a steward of the macroeconomy, Mr Brown has earned his reputation for financial responsibility rather well.

The government has proposed the introduction of legally binding targets for the reduction of carbon emissions. A carbon budget would be set every five years, with the government being legally accountable for the meeting of this target.

The proposal has been welcomed cautiously by most commentators. The caution relates to the five years period. While five years is the maximum lifetime of a parliament, typically general elections are called after about four years. So one government could blame a failure to meet the target on a previous regime.

An obvious way around this problem would be to set a target for the lifetime of a parliament. A target, achievable within five years, could be set. If the target is not met by the time a general election is called (whether that is after five years or sooner), the government could be made liable. This might encourage governments to buy electoral flexibility by meeting targets sooner rather than later.

The government has published a report by David Freud which argues in favour of allowing private companies to offer (at the government's expense) one to one support to long term unemployed people to help them get back to work. This will, no doubt, be regarded by some as a privatisation of JobCentres. It is to be welcomed.

The incentives that would be offered such firms are clear. The incentives facing public sector JobCentres are (by way of contrast, and probably inevitably) blunt. So this would seem to be an idea well worth trying out.

The world's stock markets have been in a state of some turbulence over the last couple of days. The trigger was a widespread belief that the Chinese government was about to start taxing speculative gains on the markets. Share values tumbled across the world.

Some stability has returned, in some quarters at least, following an announcement from China that no such new policy is in the works. But prices have continued to fall in the UK today. Meanwhile, prices appear to be bouncing back in the New York exchanges - which of course open later in the day - so there is cause for optimism that some stability should be restored to the market soon.

Nevertheless, this episode betrays some nervousness in the world's stock markets. While there is no strong evidence to suggest that shares are overpriced, policy changes in key parts of the world can clearly have dramatic effects. It used to be the case that if America sneezed, Britain would catch a cold. Such has been the impact of globalisation, and such has been the growth of the Asian economies, that it is now the case that if China sneezes the rest of the world catches a cold.

The headline inflation rate is up to 3%, a full percentage point above the target rate. It is now easy enough to understand the interest rate hikes of recent months. While much of the underlying activity suggests that this is a blip - oil prices have fallen back since they hit their peak, there has been a slowdown in industrial prices - the Monetary Policy Committee has been right to be cautious. (And with hindsight I now think that I, along with the minority of MPC members who did not vote for the interest rate hike in November, was wrong to want to hold the interest rate at 4.75% at that stage).

Will there be further increases in the interest rate? Possibly. The MPC will need to watch very carefully for signs of inflation feeding through into higher wage increases. The first signs, earlier this month, were that such a feed-through is indeed happening, but these settlements were in the idiosyncratic pharmaceuticals industry. A clear message from the Bank of England now, to the effect that further increases will become inevitable if there is no wage restraint, could do much to help.

Today's interest rate rise, to 5.25%, follows the news earlier this week about high wage deals being struck in the last few days. As I have written before, it is far from clear that these recent deals are symptomatic of a general trend for higher wage settlements, but it is clear that the Monetary Policy Committee has seen enough to persuade them that they need to pursue an aggressive stance. Hopefully by hiking rates now, the need for further increases can be avoided.

Today's report by Income Data Services suggests that pay inflation is starting to cause a problem for the UK economy. In January so far, the median level of pay awards has been of the order of 4%, well above the rate of price inflation.

Firms can finance pay increases in a number of ways. Productivity gains are the most attractive. If a firm awards a wage increase in excess of the rate of productivity growth, however, it must find some other way of funding the hike - price increases, which themselves fuel inflation, are an obvious option.

The recent data suggest that negotiators are starting to build inflation into their pay awards, and if this is true then the Bank of England's Monetary Policy Committee will need to consider further interest rate hikes in order to bring inflation back down to target levels.

So far, the evidence is little more than anecdotal. The pay awards have been led by pharmaceutical firms where productivity gains over the last couple of years have been substantial. New drugs such as Abilify and Viagra have generated new markets for these employers, and have therefore allowed them to make pay awards which, in themselves, may not be inflationary. For several years now, the chemical industry (of which pharmaceuticals is a part) has been a strong performer in the UK in productivity terms. What is key now is how other employers respond.

It seems likely that the Monetary Policy Committee of the Bank of England will raise interest rates today. This has been widely predicted since the last hike two months ago. But there are some very recent signs that the economy's buoyancy may not be sufficient to warrant such an increase. Manufacturing output has fallen for the first time in months, growth in industrial production has slowed almost to a standstill, sales on the high street have slowed down, oil prices have fallen, the trade deficit has shrunk, and business confidence is down. It is rare for the MPC to confound the commentators in the press, so I expect interest rates to go up - whether that is a good thing or not is another question.

Nick Stern's review of the economic implications of enviromental change, published today, sounds a stark warning. Unless investment, amounting to 1% of the world's gross domestic product, is undertaken to stave off the detrimental effects of global warming, global gross domestic product will be between 5 and 20 per cent lower than it would otherwise be by 2050. At the more pessimistic end of that scale, that is tantamount to a catastrophic recession. At either end of the scale, it makes investment now seem a good option.

A large part of the policy debate on the environment takes the form of discussion on taxes. This has been dreadfully timid so far. New taxes are never the way to an electorate's heart. A braver approach would be to switch on a large scale between existing forms of taxation and environmental taxes. Seriously slash income tax and replace it with much higher taxes on petrol and air travel.

This would have a beneficial side-effect - it would make the payment of taxes more optional, in the sense that it would be largely the consumption of pollutants that determined one's tax bill. Of course, some income tax (and taxes on other things) would still be necessary, if only for redistributive purposes. But the brave course of action for any political party now would be a promise a full review and reform of the structure of our tax system in an eco-friendly way, keeping all options open.

The Bank for International Settlements (BIS) has warned that inflation targeting using the interest rate may, in the near future, prove insufficient to guarantee macroeconomic stability. Such targeting has served us well over the last 10 years or so, giving a long period of sustained growth with low inflation and low unemployment.

But now the macroeconomy is facing new challenges. Fuel price increases threaten to push up inflation (unless people's expectations of future price rises can be held in check). At the same time higher production costs feed through into higher prices for goods and services generally, and so the demand for real output falls, threatening employment. Meanwhile, (more controversially) the BIS contends that globalisation necessitates speedier and more drastic adjustments that could make it more difficult to achieve economic stability.

If a repeat of the 1970s stagflation is on the cards - and I'm sceptical about this, but if it is - then clearly more than one policy instrument will be needed to control the macroeconomy. As Tinbergen pointed out, we need as many controls as we have objectives. If we have an employment objective as well as an inflation objective, we must have (at least) two controls. The BIS seems to be appealing for more policy power to be given to the central banks.

Traditionally the policy controls used to pursue macroeconomic objectives were monetary and fiscal policies. Monetary policy is already typically determined by the central bank. Fiscal policy remains in the control of politicians. We have done well under a system where macroeconomic policy has been separated from political influence, but it would make no sense to delegate fiscal policy to the monetary authorities.

The policy implications of a new stagflation are not, therefore, very attractive. The best option for politicians now is to do all they can to stamp out any inflationary pressure by aggressively seeking to reduce people's expectations of inflation. Wage demands must be talked down, and union militancy resisted. Although I do not share the pessimism of the BIS, the stakes are high.

Inflation has risen to 2.2%, slightly above the Bank of England target figure of 2%. This is causing a little discomfort and uncertainty about the way interest rate policy should go in the coming months, not least because unemployment has also been rising over the most recent period.

The authorities should certainly not accommodate inflation by relaxing monetary policy in a repeat of the mistakes of the mid-70s. That said, while the smart money continues to be on an interest rate hike over the summer months, it is not altogether clear that that is the way to go either. The interest rate increases in the Eurozone and the US appear to be having an effect in dampening demand, and that - migrated into the UK through foreign trade - might be enough to take the heat out of the domestic economy.

The signals are clear enough that we can rule out an imminent cut in rates. Whether the interest rate needs to rise or not then depends on wage pressures. If expectations of wage increases build up, then the one-shot blip of inflation due to the rise in energy prices will threated to turn into sustained inflation. An interest rate hike would be needed to fix that. If the authorities can manipulate expectations successfully so that union pressure for increased wages does not mount up, then increased interest rates may not be needed after all.

Spin gets a bad press. But, now more than ever, outcomes in the real economy depend on how convincing the politicians can be in urging wage restraint.

The recent announcement of the loss of 900 jobs at the Vauxhall car production facility at Ellesmere Port has raised issues about the UK's competitiveness. For sure, much manufacturing capacity in the vehicle production industry is being transferred to countries such as the Czech Republic and the eastern part of Germany where labour costs are lower than in the UK. But this is not the only issue being debated.

Union leaders have claimed that job losses in the UK are particularly severe because labour laws in this country are less tough than elsewhere, making it relatively easy for firms to lay workers off. While doubtless this does explain in part why the 900 jobs at Ellesmere Port have gone (or, at least, why they've gone now rather than later), the claim of the union leaders tells at most only part of the story. There is plenty of evidence to suggest that tighter labour market regulation leads to firms hiring less labour. The harder it is to fire workers, the less likely firms are to hire them.

So while job losses may be due in part to slack labour market legislation, many of these jobs may not have existed in the first place if it weren't for that same slackness. Britain's recent record of employment growth compares very favourably to that of our European partners, and our institutional and legal framework has to take a good bit of the credit for that. At the level of the individual, of course any job loss is terrible news. But that doesn't mean that our labour laws aren't performing well across the piece. The evidence suggests that they are.

Chancellor of the Exchequer, Gordon Brown, has been speaking out against protectionism. He is right to do so. While many interest groups see protection against foreign competition as desirable, it is in fact a thoroughly discredited policy; indeed it is as doomed to failure as Knut's efforts to hold back the tide.

Some things are better produced in some places than others. Climate, natural resources, skills are all unevenly distributed across countries. It is therefore efficient for countries to specialise, concentrating on producing the things that (relative to other countries) they are best at. This principle, known to economists as 'comparative advantage', is closely related to the division of labour; the advantages of specialisation are so strong that they constitute the strongest of market forces. While workers in heavy manufacturing industries in Britain or America may want to protect their jobs by lobbying for restrictions on the level of imports, such policies can offer only short term relief, making the inevitable outcome more sudden and unmanageable when it comes.

If producers in other countries can produce certain types of goods more cheaply than we can, then let them. Let's enjoy the cheap imports. And let's concentrate our resources on producing the things that producers elsewhere are not so efficient at producing. That way they can enjoy our cheap exports. Everyone gains. This freedom of trade is something that the European Union and other trading blocs were created to foster, and we should ensure that it is a freedom that applies not only within but also between blocs. It means we have to have a flexibile labour market, with people willing to retrain as they progress through their careers. The alternative is sclerosis.

Free trade does, of course, mean that goods need to be moved around the planet more than would be the case if we did not trade freely. But efficient movement of goods is cheap and - with the exception of a very few highly perishable goods such as cut flowers - involves a negligible environmental cost. On the flip side of the coin, the damage done by not trading freely is measured by the poverty to which rich countries - by imposing protectionist tariffs, quotas and regulations - condemn people in the developing world. That is appalling.

Good call, Mr Brown.

A fascinating and very instructive new article by Nicholas Bloom and John van Reenen compares productivity and managerial competence across four countries. They find that managerial competence is a key determinant of productivity (and of other key performance indicators for firms). Managerial competence in the UK lags behind that in Germany and the US.

The authors argue that a major reason underpinning this is the system of primo geniture, under which family firms are passed down generation to generation, with management of the firms being carried out by people who are chosen for who they are rather than what they can do.

If the authors are right - and their study is indeed a very careful one - then there are obvious implications for policy, ranging from inheritance tax, through support for business schools, to a requirement that senior appointments in privately owned businesses should be advertised and demonstrably made on the basis of merit.

Which way now for UK interest rates? Interest rates have risen of late in other major markets, including the Eurozone and the US. Oil prices have risen dramatically, and the fear is that this reflects a rise in fundamentals, not just a blip. This leads some observers to worry about a rise in inflation; although the oil price hike will surely affect prices in a one-off manner, if people start to build price rises into their expectations of inflation this could lead to a prolonged inflationary episode similar to the experience of the 1970s. So that makes a case for a hike in interest rates in order to defuse inflationary pressure.

Other observers are more cautious, citing levels of business confidence that are still low. Indeed some are calling for a cut in interest rates.

The clever betting has to be on interest rates remaining constant when the Monetary Policy Committee makes its decision later today. But, given the signs of economic renaissence in the UK's trading partners, I would suspect that the next move in interest rates - if there is to be one anytime over the next six months - is more likely to be up than down.

A recently published report by New Philanthropy Capital challenges the government's claim that City Academies offer donors an attractive investment in education. The City Academies have been particularly controversial in recent weeks because they lie at the heart of the 'cash for honours' allegations.

Only 27 academies have been set up so far. Of these, 10 are currently in their first year of operation. Of the remainder some are new schools, while some are replacements for pre-exisiting schools. In their most recent review of the programme, Price Waterhouse Coopers analysed this latter group, and found that GCSE grades (as measured by the percentage of pupils achieving 5 or more GCSE qualifications at grades A*-C) have risen in half of the schools following their conversion into Academies, and that grades have fallen in the other half of schools. While it's still early days for the programme, this is not a ringing endorsement.

Other measures are more positive. Stakeholders - pupils, parents - comment favourably on the learning culture, the attitudes of staff, and the quality of leadership in the Academies. If these qualities can, over time, translate into higher grades, then the Academies may yet turn out to be a good investment.

The running costs of Academies are comparable to those faced by conventional schools. Set-up costs are about £7m higher (because Academy buildings are often designed specifically to meet specialised pedagogical objectives). We know, from research by Gavan Conlon, that people who achieve 5 A*-C grades at GCSE typically earn around 11% more than those who don't (holding other things equal, and assuming that getting the GCSEs doesn't lead to getting further qualifications). Aggregated (and discounted) over a lifetime, that's worth around £50000. If, by changing from a school into an Academy, around 7 more pupils per year could achieve 5 A*-C grades at GCSE, then - over time - the investment could pay off. In year groups of 100, that means a 7% improvement in the performance measure. That's quite a demanding target to meet, albeit not an impossible one.

More interesting questions concern exactly what characteristics of Academies might deliver these benefits - and can these characteristics be obtained more cheaply than at present? Is it expensive new buildings that do the trick, or is it good leadership, or is it motivated teaching staff, or is it subject specialisation, or is it freedom from regulation?

Those philanthropists who are considering backing an Academy should bear all of this in mind. The Academies are not a sure-fire bet in the quest to improve educational standards. New Philanthropy Capital suggests that providing support for out-of-hours school activities, tackling bullying, and supporting special educational needs can all represent safer investments. The benefits of these alternative programmes - which are certainly less glamourous than Academies - have not been quantified in a way that makes it possible to compare them with the benefits of Academies, and without further evidence it would be difficult to concur completely with the New Philanthropy Capital view. But their report certainly poses the right questions.

Labour market rigidities cause unemployment. Rigidities are themselves often caused by institutions - those institutions may be unions, regulations, standards... or even, perversely enough, employment protection legislation.

There is ample and unambiguous evidence that employment protection legislation serves only to reduce employment. This evidence comes from many different countries, and over many different time periods. The reason is easy to surmise - the tougher is employment protection legislation, the more reluctant are employers to hire labour in the first place, because once hired it can't (easily) be fired.

The demonstrations in France are aimed at a relaxation of employment protection for young people. The policy is proposed specifically to attack a problem of high youth unemployment - and it's a policy that should work. The winners from the policy will be currently unemployed youths. The losers (and there will be some) will be young people who are currently in work, and who will lose out in terms of their job security.

The protests began with students - young people who most likely will find work and who up till now have been beneficiaries of excessive employment protection. We should not forget that - they are not being altruistic. They are not thinking of their less fortunate contemporaries. The latter need the new legislation in order to raise their probability of finding work.

One hopes that the French government will not capitulate in the face of protests by a curious coalition of privileged rent-seekers and the poor misguided and uninformed.

The 2006 UK Education and Inspections Bill recently passed its second reading in the House of Commons. The bill has been controversial, relying on support from opposition members of parliament for its passage to this stage. It comprises a number of major elements:

Schools may opt to become trust schools, owning their own assets, employing their own staff, and setting their own admissions criteria - independent of local authorities.

The local authorities, meanwhile, will develop a strategic role which will promote quality in all schools within their jurisdiction. They will also be required to play an active role in promoting parental choice.

Admissions procedures will be tightened up, so that schools have to abide by their policies (not merely have regard of them). Interviewing of pupils will be banned, and the ban on selection by academic ability will be reaffirmed - except for the 164 grammar schools that are still in existence.

There are a number of other provisions, which include such things as school meals, the right for staff to discipline pupils, and the creation of specialised vocational diplomas.

The main reason for Labour revolt over this bill would appear to be the creation of the trust schools - which are similar to the grant maintained schools introduced by the last Conservative administration. By removing many schools from direct control of the local authorities, this effectively separates the schools from the political process. Many people other than the Labour rebels might regard that as a rather good thing.

A little discussed aspect of the bill, however, concerns the creation of specialised diplomas. The role of the state in creating qualifications has not in the past been a distinguished one. Think of the NVQs. Unfortunately this part of the bill has all the hallmarks of an accident waiting to happen. There are two aspects of the proposal with which I am uncomfortable. First, the diplomas are intended to be vocational in nature. There is, however, no evidence to suggest that education at this level should be take the form of vocational training. In a fast changing economy, general education, providing as it does the skills with which people can become adaptable and amenable to lifelong learning, provides much higher returns. Secondly, any new qualifications would stand the best chance of success if they were to be created and validated by a private sector body. This would ensure that market pressure is brought to bear that should guarantee the usefulness of the qualifications.

Gary Becker provides an interesting defence of capital punishment. His argument hinges on the deterrence effect. While the strength of this effect is a matter of some debate, he argues that even where less than one innocent life is saved as a result of killing a guilty murderer, society may benefit from capital punishment, since the positive value to society of the murderer is likely to be less than that of the innocent victim. "A comparison of the qualities of individual lives has to be part of any reasonable social policy."

This statement is, of course, far from innocuous - especially so if we remove it from the emotive context of capital punishment. It is particularly controversial because it begs the question of who should make the decision about the qualities of individual lives. If different people are to carry different weights in society's welfare function, how should democracy work? Do currently installed governments have a mandate to make decisions on this? Should the governments now in place therefore allocate variable numbers of votes to members of their populations in time for the next elections? Should these be based on criminal records, access to welfare payments, education, gross income, or contributions to party funds? Under such conditions, democratic government would amount to little other than a one party state. So should it be a dictator that decides on the weights? That would be convenient, to be sure, but one dictator's tea is another dictator's coffee.

Unless Becker can tell us how and by whom the comparison of the qualities of individual lives should be made, his argument is no more than subjective opinion - in his view, we should count some people's lives as worth more than others. In the context of capital punishment, his opinion may have a lot of public support. More generally in the construction of social policy his would be one voice amongst many, and each of those voices would like to be able to dictate.

All this is not to suggest that economists can, or should, refrain from making comparisons of the qualities of individual lives. Indeed we cannot avoid doing so, for assigning an equal weight to each individual involves making comparisons just as does the assignment of unequal weights. But reaching a judgement that at the margin one life is worth more or less than another is something that we should do only in the most exceptional of circumstances, and in full cognisance of the implications. For amongst those implications is the undermining of much of our discipline as we know it. Utilitarianism would be out, and with it much of welfare economics would go. Even the invisible hand, which provides the intellectual foundation stone of free market economies, and which assumes that one agent’s welfare is worth the same as another’s, would be seriously compromised.

Now that's a funny thing to come out of Chicago!

Energy prices have been rising very dramatically of late. Those with long memories will be reminded of the 1970s. At that time, oil price hikes led to general price increases, and many governments (notably the UK) sought to accommodate these by increasing the money supply. The result was rampant inflation.

Is inflation likely now? Certainly a one-shot increase in prices is likely and that will cause a blip in inflation. A major difference between the current situation and that of the 1970s, however, is that the central bank has autonomy to determine monetary policy. Its reaction to an inflationary blip is likely to be a temporary rise in interest rates which will serve to reduce inflationary pressure. This is the opposite of the policy mistake that was made in the 1970s.

So while the increase in energy prices hurts, it is reassuring to know that it is unlikely this time to be translated into a sustained and high rate of inflation. And, who knows, it might even have a beneficial impact on the environment.

Britain's big supermarkets - Tesco, Asda, Sainsburys and Morrisons - are under investigation. The charge is that they are dominating the market and crowding out smaller providers. This is seen as being detrimental to local communities.

There are advantages and disadvantages associated with big stores. They exist because they can take advantage of economies of scale. These include, most obviously: spreading out advertising costs amongst many stores within the chain; the ability to arrange for the production of discounted 'own brand' goods; human resource management; a rationalised distribution network; administrative and other overhead savings. These economies of scale are likely to be substantial, and advantage should be taken of the savings that they allow.

There are other advantages that the supermarkets have in the market, however. With such a high degree of concentration of market power, they can use their weight in the market as a means of exploiting their suppliers. In economists' parlance, they can abuse their monopsony power. This means that small suppliers - including many farmers - find their profit margins squeezed to the point that they go out of business. This is not welfare-enhancing.

Moreover, the increased dominance of large, often out of town, superstores has implications for the car useage and the transport infrastructure more generally. The environmental and social cost of superstores - compared with the availability of local shopping - needs to be borne in mind in any assessment of welfare.

So the supermarkets do indeed need investigating. Striking the right balance between exploiting scale economies, on the one hand, and preventing the anti-competitive exploitation of suppliers, on the other, will be a challenge. That the authorities should at last have risen to meet the challenge is welcome news.

In August of last year, I hinted on this blog that interest rates might be reaching levels that were threatening economic growth. The Bank of England's Monetary Policy Committee (MPC) is required to hit an inflation target, and it moves interest rates in order to hit that target as closely as possible. But it is not required to aim for any particular rate of economic growth. We are now seeing the effect that policies that are suited for one purpose can have on another key indicator of macroeconomic performance.

The Chancellor of the Exchequer has slashed his growth forecast for 2005 to 1.75%, just half the rate that he forecast just a few months ago in the Budget. He blames this in part on oil prices - though oil prices have affected also the economies of mainland Europe that are now growing faster than that of the UK. The UK's own monetary policies - the responsibility for which is now of course (quite rightly) devolved to the Bank of England - have as much to do with this year's disappointing growth outturn as anything else.

Fortunately, the UK economy looks set for a soft landing, with growth remaining uninterrupted into another cycle. In the longer term, the relationship between the MPC target and other key macroeconomic variables is something that may need to be revisited if we are to avoid less fortunate economic outcomes.

Gordon Brown is at it again - he has once again changed his definition of the economic cycle. A few months ago, he redefined the start of the current cycle from 1999 to 1997, a controversial move on which I have written earlier. Now he wishes to redefine the end of the cycle to 2007.

This latest move is truly bizzare. He has described, with some justification, the current year as 'the toughest year'. If that is the case, then surely this is when the cycle ends. The move to redefine the end of the cycle to 2007 is transparently a ploy to boost the public finances with the fruits of a couple of years of above par growth. There's nothing particularly wrong about that, but the Chancellor should stop pretending that he is adhering to some sort of 'golden rule' when the truth is that he keeps moving the goalposts.

In his pre-budget statement, the Chancellor has revised growth forecasts for the current year down to 1.75 per cent. This is just half the growth rate he was predicting at the time of the Budget earlier this year. To be sure, some of the slowdown is due to rising oil prices, but they affect the relatively fast-growing economies of mainland Europe too. More pertinently, the slowdown is due in part to restrictive monetary policies. Back in August of last year, I was hinting on this blog that interest rates might have been hiked too far and too fast. We are now seeing the fruits of the Monetary Policy Committee's decisions of 15 months ago - while those decisions were arguably in line with the MPC's need to meet an inflation target, we are now seeing the consequences of their decisions on economic growth, an important variable which the MPC does not target.

Tony Blair is making last ditch attempts to secure agreement on the EU budget. He says that there is no question of the UK giving up its rebate, other than in exchange for wholesale reform of agricultural support. Yet he is willing to see the rebate reduced (as opposed to scrapped) in order to secure an agreement - and this without any corresponding cut in support to other countries through the Common Agricultural Policy (CAP).

The desire to seek a deal during the period of Britain's presidency of the EU (which ends at the end of this month) is natural enough. But Mr Blair has left it until the eleventh hour before making any strenuous efforts in this direction. The consequence is that he has had to offer up a key bargaining chip in order to secure the support of the eastern European accession countries. They may be (and it is only a maybe) willing to cut some of their calls on the EU budget for development if the UK is willing to sacrifice something too. So - since the UK has the presidency and since Mr Blair can make decisions for Britain but not for other western European countries - the UK offers up a slice of its rebate.

This is politics liberated from any economic rationale. The UK's rebate was set up to ensure that - so long as the CAP existed and distorted budgets - the UK got a fair deal in relation to other western European countries. If there is no change in budgetary arrangements for the other western European countries, the rebate should remain intact. It is doubly important that it should do so, since the rebate serves as Britain's only pressure point on other countries to reform the CAP. Mr Blair is playing dice with our ability ever to cure Europe of its most damaging institution - one that penalises consumers, hurts farmers in developing countries, and sustains inefficient agricultural practices within Europe.

Mr Blair's offer seems to be to cut the rebate by about half a billion pounds per year. At a time when his Chancellor, Gordon Brown, is struggling to plug the hole in the public finances, the Prime Minister's largesse could not be more unwelcome.

Gordon Brown is in the news again. It seems that he is intent on blocking one of the proposals made in the forthcoming Turner report on pensions reform. That proposal would reinstate the automatic link between pensions and the average earnings index, and would (eventually) raise the age at which people become eligible for the state pension to 67 years.

This is another example of a knot in which the Chancellor has managed to get tied. Index linking of pensions obviously reduces the degree of control that he has over public expenditure. He needs to rein in that expenditure as far as possible at present, because tax revenues are currently falling quite a long way behind expenditures. In other words, the public finances are in a mess, and the Chancellor is in no mood to sign cheques. The shortfall of tax revenues was predictable and predicted.

Most economic commentators have been less sanguine than the Chancellor about the propspects for growth over the last couple of years; they, not he, turned out to be right, and the consequence has been that incomes have failed to rise sufficiently quickly to fill the Treasury's coffers.

Mr Brown owes economists an apology. But before that, he should apologise also to the pensioners and the public sector workers who will pay the price for his mistake.

Gordon Brown, Chancellor of the Exchequer, has urged public sector pay review bodies to keep pay settlements down below 2% over the coming year. This is in spite of the fact that price inflation has been above 2% for several months now.

He is right. The recent surge in inflation has been a blip, fuelled largely by the increase in oil prices. Over the last couple of months, however, oil prices have fallen, and so has inflation. Last month's inflation rate (excluding mortgage interest) was 2.3%, down from 2.5% the month before. To allow high settlements in the coming pay round would risk perpetuating the blip in the same way that the oil price blip of the 1970s was perpetuated. Then, inflation rates rose to 28%, an experience we would rather avoid repeating.

However, there is also a more cynical reason why Mr Brown would like to see public sector pay restraint. Owing to his overoptimistic growth forecasts, tax revenues are lower than he expected. As a result, there is a gaping hole in the public finances. High public sector wage settlements would aggravate this situation.

While Mr Brown is right to urge for pay restraint, it is nonetheless the case that public sector workers are being expected to pay for the Chancellor's own lack of prudence.

There is a lot of public pressure on the UK government to respond to the petrol price situation by lowering duty on fuel. While all parties in the discussion understand that it is international factors that have pushed up the price of petrol, there is much disquiet about the fact that the government's tax take on petrol has risen - because while the duty is a fixed sum, VAT is raised as a percentage. There are therefore accusations that the government has allowed the VAT windfall arising out of the petrol price hike as a kind of stealth tax. This is what is causing people to call for a reduction in the rate of duty.

Should the government respond? I think not. If they did, it would signal to the petrol producers that they are prepared to absorb (in the form of a reduced tax take) any further increases in the price at which the petrol is sold to the garages. This would insulate the petrol producers from the disciplines of the market - and the profits made by the petrol giants do not suggest that their industry is sufficiently cut-throat to ensure that Shell, BP and the rest will discipline each other through competition. (Shell and BP each make annual profits that are roughly the same as the national incomes of countries like Estonia, Cyprus, Lebanon or Botswana; about twice as much as the national income of Niger.)

If government cut duties, petrol companies would likely hike prices again.

The root cause of the current difficulty in the petrol market is high demand (much of it speculative) and OPEC-restricted supply. The high demand is something we're going to have to learn to live with. The artifical restriction of supply by the OPEC cartel is likely to continue for a while yet, although political pressure in advance of the OPEC meeting on 19 September could possibly bring about some easing of the situation. Eventually - as happened in the 1970s - the cartel will find the maintenance of high prices unsustainable, but that could take some time.

The petrol price protesters are out in force again. Oil prices have pushed the pump price to an unprecedented £1 per litre in the UK. In a country where travel by car has become the norm, the rapid price increase has understandably made many people unhappy.

Demand for oil is forecast to rise dramatically over the next few years, as the rapid pace of development in the large high growth economies of China and India brings motorised transport within the budget of many more people. With some forecasters predicting a rise in the per barrel price of oil to over $100 within two years, it is hardly surprising that the demand has increased now, when prices are 'only' $57.

To be sure, the high price is being sustained by the behaviour of the OPEC cartel, which is restricting output to around 28 million barrels per day. While prices are on the rise, discipline within the cartel is likely to be maintained; members of the cartel will recognise that they are better off not breaking the output quotas agreed within the organisation just yet. (Or at least not breaking them too wildly - OPEC recognises that its members do in fact break the rules.) The cartel is the real reason why output is restricted. Of course oil supplies are not infinite, but it's cartelisation rather than limited supplies that is the immediate problem. OPEC will be meeting on 19 September to review its quotas; we can expect there to be a lot of international pressure on them to increase supplies in order to dampen the upward pressure on prices.

In the 1970s, restrictive practices by OPEC brought about inflation on a grand scale in the UK. That happened because the government of the day 'accommodated' the oil price rise by relaxing monetary policy. That led to a general and sustained increase in prices - inflation. So long as today's authorities keep a tight rein on monetary policy, there is no reason why that episode should be repeated. But it does make it likely that the interest rate will need to be increased in the near future.

The European Union's dispute with China about textile imports comes like a blast from an unwelcome past. It exhibits the EU at its worst.

At its best, the EU exists to promote free trade - albeit free trade within a prescribed trading bloc. Free trade encourages the most efficient international pattern of production possible. If we are best off when France produces wine and Italy produces pasta, then that is exactly what free trade will stimulate. We will get relatively cheap wine from France and relatively cheap pasta from Italy, and - given an amount of money to spend - we'll be able to buy more wine and pasta than we could under any other production arrangement.

In the case that is now making the headlines, China wants to sell the EU cheap textiles. I say let them. The EU says no. The EU is concerned about European jobs in the textile industry, and is imposing protectionist policies to prevent what they consider to be excessive textile imports from a low cost producer. But why not let China do what it is good at, and let us concentrate on producing things where we have a comparative advantage?

For some textile workers in the EU, this might mean adjustment. It might mean reskilling, either to move up the value chain in the textile industry, or to move out of the textile industry altogether. Change hurts, and that being so, the EU is resisting the change. But change is also inevitable, and if EU labour markets do not act flexibly now, they will be forced to do so, more painfully, later.

Meanwhile, the EU is seeking to deny hundreds of millions of European consumers the right to choose between cheap imported textiles and more expensive domestically produced goods.

And all the time the tide keeps rolling in, and the EU still needs to learn from the experience of King Cnut.

China has unpegged its currency from the US dollar, and has revalued the renmimbi by 2%. This will make its exports less competitive, and will make it easier for other countries to export their goods to China. The Chinese currency will now float against other currencies, but the float will be managed by reference to a basket of currencies of its major trading partners. This lessens the influence of the (relatively weak) dollar in determining China's trade.

Inflation in China remains low, at below 2%, and growth has eased somewhat from the supercharged 13% figures of a few months back. Domestic pressure for the change in policy is unlikely to have been the driver, therefore. But the Chinese government has come under increasing pressure from other countries to free its currency. Notably, the US, with which China has a huge trade surplus, has been especially keen to gain leverage from the extra degree of freedom that independent exchange rates for the two giant countries can afford. For Americans (as for Brits, and as for China's other trading partners) the move may make flashdrives slightly more expensive, but will it will stimulate their economies. This is welcome news.

Chancellor of the Exchequer, Gordon Brown, has a reputation for prudence, won largely as the result of his careful management of the economy during the Labour government's first period in power. Since then he has been more relaxed about spending, and the government budget surpluses earned in the early years have turned into deficit. Key to his prudent image has been his self-imposed 'golden rule' that, over the course of the business cycle, government should not borrow other than to pay for capital investments.

During the current cycle that golden rule looks like being breached. Or at least it did until the Chancellor employed a sleight of hand to give himself more wiggle room. That sleight of hand entailed redefining the time when the current cycle started from 1999 to 1997. Since the government made a surplus in 1998, this gives him more to play with.

Certainly the case for stating that the cycle began in 1999 always looked weak. Growth was much higher then than in 1997. So far so good for the Chancellor. But if we roll the years forward to 2000, things don't look so compelling. In that year, growth dipped once more, and indeed on some measures growth was slower in 2000 than in 1997. The Chancellor was right to change the date that the cycle began. But he still hasn't got the right date.

Since the years after 2000 have been characterised by government budget deficits, the truth of the matter is that the golden rule is being broken in style. Fortunately this has not yet led to inflationary pressure, but it does build up problems for the future. Taxes will need to rise to pay for the excess government spending, and if people anticipate those tax rises they will be cautious about their own spending now. Consumer pessimism dampens demand and stifles growth, making it all the harder for the Chancellor to meet his targets. Unless he starts to pull rabbits out of hats (without a sleight of hand this time), the Chancellor's reputation for prudence is set to wane.

I have, for decades, been a supporter of Christian Aid, both through regular donations and as a door-to-door collector. I have, however, been appalled by half page advertisements placed by the charity in today's newspapers. They exhibit a dreadful level of economic ignorance.

The advertisments argue against free trade and in favour of 'fair trade'. They cite the particular case of onion farmers in developing countries whose output is priced out by cheap imports from Europe. Let's disentangle that example.

Suppose trade is free. European farmers could price out farmers in developing countries only if they could produce onions more cheaply. If this is the case, then people in developing countries should consume the European onions, and be grateful that their own farmers can then be freed to produce something else - something that they are better (in relative terms) than the Europeans at producing. That way everyone gains - in the developing countries they get cheap onions and their farmers can switch to producing something that earns them more income. This is the principle known to economists as comparative advantage, and it supports the argument in favour of free trade. To be sure, the transition of switching from producing one thing to producing another can be painful, but it is a transition that has to be made sooner or later - as countries as diverse as the UK and the USSR discovered during the 1980s, you can't buck the market forever.

There is another possiblility. Maybe trade isn't actually free at the moment. Maybe European farmers are dumping cheap onions onto foreign markets. This might happen if they seek to sell their onions in Europe at prices above the level that would clear the market. To achieve this, they would have to restrict supply to Europe by selling cheaply abroad. This certainly would not be fair trade, and if this is happening, Christian Aid would be right to oppose it. But by the same token, this is not free trade either.

I regret to say that Christian Aid has got it very wrong. They should be arguing for, not against, free trade. Free trade is fair trade.

The Conservative party has today published its proposals for the funding of higher education in the UK. The proposals involve the scrapping of all tuition fees, and an increase in the interest rate paid by students on student loans. Students will gain from the former and lose from the latter, but on average will be better off.

By scrapping tuition fees, universities and colleges will be denied an important source of income. To alleviate this, the Conservative proposals include an intention to hand over to the higher education institutions themselves the claims on student debt. The universities and colleges could then sell this debt to financial institutions, releasing funds that can be spent now to alleviate the funding crisis in higher education.

These proposals raise a couple of interesting issues. First, if universities and colleges are given the authority to claim back student debt, it is not at all clear that they would be able to do so through the income tax system. The innovation of income-contingent loans was one of the most attractive features of the reforms ushered in in the wake of the 1997 Dearing Report. If loan repayments are not contingent on income, a return to mortgage type loans would be very hard on graduates who fail to get high paying jobs, and on those who interrupt their careers for family reasons. Presumably it would be possible for the universities collectively to subcontract the loan repayment process to the government tax collectors, but it is not clear that this is what the Conservatives have in mind.

Secondly, while it is clear that the Conservatives wish to allow the universities and colleges to receive loan repayments from students, it is not clear where the money to make the loans will come from in the first place. If the government makes the loans (as now), it will need to find the money to do so. If the higher education institutions make the loans (and one wonders whether this might be the hidden agenda), then it is not clear that the new proposals will do anything at all to solve the higher education funding crisis. There seems to be some alchemy at work here, a black hole at the heart of the proposals.

The higher education sector faces a funding gap of between £6 billion and £10 billion per year. If we want an effective higher education sector, that gap has to be plugged. Alchemy will not plug it, and it seems that the introduction of differential tuition fees remains the only really persuasive and honest proposal in town.

Interest rates are up again today, to 4.75%. This is the fifth hike in the last 8 months, and suggests continuing concern in the Bank of England about inflationary tendencies in the UK economy.

The latest figure (for quarter 2, 2004) for the annual rate of growth of real GDP is 3.7% (up from 3.4% in the first quarter). As a measure of unemployment, the claimant count is still falling, and has been below 900000 throughout 2004. These are both signs of a buoyant economy.

The continuing rise in house prices, and concerns raised by the high price of oil, have generated some concern about inflation. But the former should be self-correcting and the latter should be a one-shot event.

The annualised rate of growth of the consumer price index rose during the second quarter of the year - from 1.1% in March to 1.6% in June. This remains low in relation to the target level, and in this respect it is surprising to witness the sustained hikes in interest rates; it seems to be a severe policy response.

There is, however, reason underpinning the Bank's policy reaction. Over the year to June 2004, lending to individuals increased by some 15%. Much of this is due to house purchases, but growth in consumer credit has also been dramatic, at around 12%. These figures suggest that, unless credit is reined back by rising interest rates, aggregate demand will outstrip supply and inflation will set in. The Bank's decisions on interest rates may therefore be seen as a response to a useful leading indicator of economic activity; rather than responding to what inflation is now, the Monetary Policy Committee is responding to where inflation might be in a few months time.

As things stand, this carries a danger. We might reasonably expect the housing market to self-correct, and we might also expect this to involve quite a substantial fall in the price of a typical house. If this happens while interest rates are still being hiked, consumers will face a double-whammy - house price collapse and high interest rates. Certainly the economy may need to be slowed down in the months ahead. But the housing market may ensure that it does some of the slowing down of its own accord - interest rates are not the only thing that can brake the economy. The MPC needs to toe a very thin line between doing too little and too much. The signs are that it has done enough for the time being.

The increase in oil prices (to over $40 per barrel) has caused much concern. Political instability in Iraq and Saudi Arabia are largely the cause, with the price of oil futures in particular being lifted as a consequence of the risk factors involved, fear of a cutback in supplies generating worries about future price hikes. Inevitably this stimulates memories of the 1970s, when OPEC, the cartel of major oil producing countries, succeeded in quadrupling oil prices. At that time, the price rises were accommodated by expansionary monetary policies in many Western economies, this fuelling inflation. Cartels are notoriously unstable, however, and it does not appear that this time around OPEC will be able to exacerbate the high price of oil - indeed major players within OPEC are committing themselves to raising supply, thereby dampening the upward pressures on the price.

Oil prices are critical determinants of the prices of many other things, owing to the importance of oil as a fuel for transporting goods. So oil prices matter. But a one-shot increase in the price of oil is not, of itself, inflationary. It does not set off a sustained chain reaction of price increases. In the 1970s, however, governments' responses to the OPEC oil price hike did set off an inflationary episode. At that time, governments reaction to the increase in the price of oil was to expand the monetary base so as to accommodate the oil price shock, that is to try to dampen the decrease in aggregate demand that is consequent to the one-shot price rise. But by expanding the money supply, the authorities merely generated further price increases, setting off an inflationary sequence.

The monetary policy response to the oil price rise now should take heed of the lessons offered by the experience of the 1970s. Interest rates should not be cut to accommodate what is happening in the oil markets. But neither should fears of inflation due to oil price rises necessarily mean that interest rates should be raised. The oil price hike is a one-off event; it does not mean that inflation has re-emerged, and the appropriate response is not a knee-jerk anti-inflationary adjustment of the interest rate.

Whether the Monetary Policy Committee should have raised the interest rate last month is moot. It should not have done so for fear of inflation in the housing market, and it should not have done so for fear of the effects of rising oil prices.

Interest rates have risen recently in the UK, with the Monetary Policy Committee apparently fearing the effects of a house price boom and bust on the overall economy. Inflation, meanwhile, remains well below the 2% target. The interest rate hike is in my view premature. Rather than ensure a soft landing for house prices, it might precipitate a crash. Holding rates constant for a while longer might have been more prudent at this time.

The debate on differential tuition fees for higher education has hit the headlines once again, with over 150 Labour MPs signing an early day motion suggesting that they are likely to vote against the government. This would be unfortunate indeed.

Since the early 1990s, funding per undergraduate student in the UK has declined from £8000 to £5000. Multiply this by the number of students in the system, and it is clear that, in comparison with the recent past, total income from this source is at least £6 billion less than it might have been. This funding gap is adversely affecting the fabric of our higher education institutions; it is adversely affecting the conditions under which our students study; and it is severely challenging the ability of our best universities to compete with the best universities worldwide. Nobody seriously doubts that the universities need more cash. The problem is: from where?

Taxing in order to improve the finance of higher education is not an option. Closing the funding gap would put 3 percentage points onto the basic rate of income tax. That is politically infeasible. In any event, it would be inequitable to impose taxes on those who do not benefit from higher education in order to fund the univerisites; it would be wrong to expect road sweepers to pay for the investment made in people who later in life get high earnings on the back of their education. The debate about this ended with the introduction of flat rate tuition fees.

At stake now is the matter of differential tuition fees. Different students study different courses, have different abilities, and have different needs. It is absurd to pretend that all benefit, and that all should therefore pay, equally for the higher education they receive. Some benefit more than others. So some should pay more than others. That is only fair.

Some people object to differential fees on the grounds that their introduction will create a two-tier system of universities. This is hogwash. Higher education institutions already charge differential fees to all postgraduates. They also already charge differential fees to all undergraduates domiciled outside the EU. Universities already receive incomes from their students that vary according to how much the market will let them charge. Courses with a strong reputation charge more than those without. What is new?

The proposals before parliament could certainly benefit from some refinement and clarification. In particular, the bursaries system that has been mooted should be administered (and in my view largely financed) by the government - only the government has a mandate to redistribute income in this way. And we need to be sure that, unlike the existing fees, the new fees should not be a stealth tax - when the government introduced tuition fees at a level of £1000 in 1999, it reduced its own funding for each undergraduate student by an almost identical amount.

Notwithstanding this, the principle of differential tuition fees is a good one. It is not right that students on courses that will benefit them relatively little should pay as much for those courses as other students on courses that will benefit them a lot. The proposals currently before parliament will remove that horrible inequity. Those MPs who are considering rebellion should consider that.

The recent decline of the US dollar has been dramatic. The stimulus for this has been the huge current account deficits faced by the US. That these deficits should emerge at a time when the American economy has not been growing strongly is a concern - as the US economy expands, more imports are likely to be sucked in, and the current account deficit will increase further. To mitigate this, the weakening dollar should at least make American goods cheaper for consumers in other countries to buy.

The flip side of the weakening dollar is the strengthening of other currencies (such as the pound or the euro) against the US currency. This makes it harder for these countries to sell goods in the US, and so will make it more difficult for the European economies to pull their way out of the recent period of sluggish growth. A strong recovery in the US is, more than ever, what Europe needs in order to stimulate growth on this side of the pond.

My work on A level curricula and subsequent labour market earnings has been generating some media interest in the last couple of days. Essentially this work takes issue with earlier studies that suggest that maths is the only A level subject that positively influences subsequent earnings.

I disagree with this earlier work because, in my view, it does not make sense to examine the labour market impact of each subject separately. Students take a curriculum - a whole set of subjects - at A level, and they do so because they expect the interaction of these subjects to pack more of a punch than can a single subject. So taking chemistry alongside, say, physics can be more effective than taking either subject in isolation - because there are beneficial spillovers from one subject to the other.

The work that I have done uses a sophisticated statistical estimation method based on neural networks to analyse the impact of all possible combinations of subjects. The results suggest strongly that:

(i) maths is not the only subject that contributes to future earnings
(ii) it is not possible to say that a narrow curriculum is more productive than a broad curriculum or vice versa - subsequent earnings depend on the precise mix of subjects studied
(iii) again, it is not possible to claim that a curriculum dominated by sciences is more productive than one dominated by arts - for exactly the same reason; subsequent earnings depend on the precise mix of subjects studied.

The results are therefore quite complicated. But, of course, that is what we should expect. The interactions between different subjects are complex indeed.

The Euro is falling against the dollar. While there has been renewed optimism in America about consumer spending, France in particular has slumped, this putting downward pressure on the Euro. The adjustment in the currency's value should help stimulate the French (and more generally the Eurozone) economy, but what effect will this have on the UK?

The strength of the Euro in the recent past has rendered British exports reasonably competitive and has buffered the UK economy from the worst effects of the downturn. With the Euro now adjusting downwards, Britain's strength is less apparent. A soft landing still appears to be the most likely outcome, but we are not out of the woods yet.

The government's publication of the results of the five economic tests for entry to the Euro has exposed the political nature of the exercise. Four (or is it two?) of the economic tests have failed, but the government's response is to put measures in place to help ensure that the tests can be passed in future. It is striking that these measures were not put in place several years ago. The reason they were not is, of course, that the five tests have served merely as a screen to cover the politicians' prevarication.

What we have needed all along - as I have mentioned before - is a cost-benefit analysis. The five tests did not produce that; they were narrowly focused tests, some of which were bound to fail (if it suited the government for them to do so) because they asked questions along the lines of how long is a piece of string. We don't need five tests to tell us that the Euro will reduce our own government's flexibility to manage the economy - we know that it will do that. What we need to know is whether the costs of that are more than offset by the benefits of a more certain economic environment. For all the huff and puff of the Chancellor's announcement, we are no nearer knowing the answer to the question that really needs to be addressed.

After a brief lull in the housing market at the start of this year, house prices have once again started to rise quickly. At present, average house prices seem to be running at about 10-15 per cent above trend, indicating that a downward adjustment is likely. The market has been buoyed in recent months by low interest rates, but it seems that the turning point will come sooner rather than later.

The overall increase in prices masks some regional disparities. In some parts of the South East prices have started to fall, while in other regions prices are still rising quite steeply. This is characteristic of a ripple effect that is quite often seen in UK house prices - changes seem to emanate from the area around London, and then spread out over a period of about 18 months to the more peripheral regions. House prices generally are, of course, higher in the South East than elsewhere - but householders everywhere should be aware of the dangers of negative equity that adversely affected almost 2 million people in the late 1980s.

Some commentators have been alarmist - with Andrew Oswald notably predicting a 30% fall in house prices over the next two years. This is, I think, a little too pessimistic. I would expect the adjustment to be about half that. But even my more modest forecast implies that large numbers of people will be hit hard by the housing market downturn. And, with rates already very low, scope for further help in the form of interest rate cuts is limited.