The US authorities are engineering a plan to stabilise the financial markets. From what we know already, it seems that this might involve legislation that forces lenders to renegotiate debt repayments with homeowners who have been struggling to pay their mortgages. So much, so sensible.

It is also suggested that the government might set up an agency that would take on the bad debt that has come from banks offering mortgages in the sub-prime market. This news has really cheered up the stock markets in a big way - with the FTSE100 gaining over 7.5% this morning. Such a big rescue may well be necessary, but it would not all be good news. It would have adverse implications for taxes in the future. People know that, and they will start spending less now in anticipation of a higher tax burden. That will slow down and maybe even postpone the economic recovery.

Such a rescue would also have implications for the regulation of the banking sector in the future. If government bails out banks, it takes away the disciplines of the market. If it does this, it must impose some rather stringent regulation in order to ensure that banks do not take excessive risks. The whole regulatory framework for financial services is set to change in a massive way.

The news on financial institutions keeps coming thick and fast. AIG has been bailed out by the US government, in what is effectively a nationalisation. Meanwhile in the UK, HBOS (the merged Halifax and Bank of Scotland company) has been hit hard by an assessment by Standard and Poor's (a major credit ratings agency) which deemed it to be the most vulnerable of the British banks. The value of shares in HBOS has collapsed dramatically in recent days, and early today had fallen by a further 40%. The latest news is that Lloyds are contemplating a takeover. Shares in HBOS have recovered somewhat since this news broke.

With rumours sending share prices of some banks spiralling downwards, it is not surprising that other financial institutions are quick to seize the opportunity of takeovers on the cheap. It is becoming clear that one thing to emerge from this crisis will be a massive increase in concentration in the banking industry, with far fewer banks competing against each other. The dilution of competition as a discipline on banks' behaviour will bring about its own issues of regulation.

After the relative calm of late July and August, stock markets have been thrown into a frenzy once more, with the FTSE100 dipping below the psychologically important 5000 barrier. This has followed the weekend's dramatic events on Wall Street, which saw the investment bank Lehman's being forced into bankruptcy, Merrill Lynch being taken over by the Bank of America, and the American International Group (AIG) of insurers widely tipped to be the next financial giant to come under pressure.

The troubles of the global financial sector are by now well documented, and the events of the last few days just go to reinforce the fact that we are now living through the worst crisis of this kind for many decades. The scale of the disturbance within the financial industry makes clear the fact that these events will have serious ramifications for the real economy.

Some observers are pointing to the Clinton administration's repeal of the Glass-Steagall Act which, until 1999, forced investment banks and commercial high street banks to be separate entities. This Act, while in force, ensured that bankers did not take inappropriate risks with funds deposited by the public. The repeal of the Act, following prolonged and intense lobbying from the banking sector, allowed banks to take advantage of economies of scale and scope, and also allowed American banks to become more effective in competing internationally. The repeal should not have introduced new hazards - credit ratings agencies (CRAs) should have been reporting on risks to the main financial regulatory body in America, the Securities Exchange Commission (SEC) who would then act on the information. In practice, the CRAs may have failed to maintain enough of an arms-length relationship with their clients, and the SEC may have failed adequately to anticipate this. Repealling Grass-Steagall hasn't helped matters for sure, but that fact should not serve to hide some pretty serious failures that have happened elsewhere in the regulatory system.

The key questions are: how these failures arise (I suspect that the incentives people face are not always aligned with what is best for society); whether the failures are endemic (I suspect not); and what institutions (regulations, mechanisms) can be put in place to prevent them. An overhaul of the governance of firms in the financial sector is needed, ensuring that the incentives that workers face are aligned with the broader need for these firms to conduct their affairs in a socially responsible manner. Economists with expertise in personnel economics (and the application of principal-agent models in the workplace) should be at the forefront in the design of these reforms.

The Bank of England has kept the interest rate at 5% this month. As I have argued on this blog earlier today, I think a cut would have been timely. Downgrade your growth forecasts for the first half of next year.

The Bank of England's Monetary Policy Committee (MPC) is set to make its latest monthly decision on interest rates later today. Many pundits suggest that the MPC is unlikely to cut rates given the continued threat of inflation, but that cuts are likely in the months ahead.

We are on the point of entering recession. Inflation has risen to above 4%, and that is a problem in the eyes of many members of the MPC - they are, after all, briefed to keep inflation close to its target level of just 2%. But oil prices have fallen back quite sharply over the last month, and the recession is likely to dampen price increases further in the domestic economy.

It takes changes in the interest rate about 6-9 months measurably to affect economic activity. The MPC needs to be looking ahead to the spring of 2009 - by which time the threat of inflation should have receded and - without a fillip - the economy will likely have suffered three quarters of non-positive growth. Given what has happened in recent weeks to the price of oil, the Committee should not delay further in cutting interest rates.

A stamp duty 'holiday' has been announced. This means that, for the next year, people buying houses costing up to £175000 will not have to pay stamp duty on their purchase. Up to now, stamp duty has been payable on all houses costing over £125000. For the next year, the 1% rate of stamp duty will kick in at the higher £175000 level.

According to the Nationwide Building Society, the average house price in the UK is (to the nearest thousand pounds) £175000. The move on stamp duty is therefore clearly aimed at helping most directly people in the bottom half of the housing ladder. Others will benefit from a ratchet effect: as first time buyers decide to buy their own homes, sellers will find that they can trade up, and so on up the chain.

The stamp duty change is just part of a package of measures to breathe new life into the housing market. Households on incomes below £60000 per year are to be offered loans that are interest free for the first five years. At the end of the five years, they will have to pay a fee - and the success of this initiative will doubtless depend crucially on the (hitherto unknown) details of that fee.

It is to be hoped that this package of measures will deliver the stimulus that the housing market badly needs. Ultimately, though, people will start to buy into housing once they believe that house prices are no longer falling. They are unlikely to be impressed by a tax break worth £1750 if they think the value of their new home is likely to fall by more than that amount over the coming months. And they will not respond to a tax break if they think that it is still going to be available in the future. So we may have to wait till towards the end of the tax holiday (and the tax holiday will indeed have to come to an end) before many people decide to take advantage of the reduction in stamp duty.

Chancellor of the Exchequer, Alistair Darling, has hit the headlines over the weekend by claiming that the economic situation may be the worst that we have faced for 60 years. At the same time, David Blanchflower, the most dovish of the members of the Bank of England's Monetary Policy Committee (MPC), has gone public on his views that unemployment could top 2 million by the end of the year, and that the Bank needs to cut interest rates further.

Other members of the MPC may feel as though there is a pincer movement here, and that, for the first time since the Bank was given independence, we are seeing some real political interference in the process of setting interest rates.

Mr Darling's comments have had an immediate effect on the exchange rate, with speculators selling sterling like hot cakes. The value of the pound has collapsed to a two year low against the dollar. This, in itself, should do something to help the ailing economy, as our exports become cheaper relative to those of other countries.

The Chancellor has received a bad press following his comments. Perhaps he has indeed been politically naive. But perhaps, given the (sensible) decisions made in 1997, he is now using the only means left open to him to influence monetary policy - without being seen to do so.

Life is tough when someone makes you the captain just as you head for the rocks, especially when you aren't given control of the rudder. As the Welsh say, 'poor dab'.

Recent work by Dimitri Ballas and Mark Tranmer on the geography of happiness in the UK has received a lot of attention in today's press.

Ballas and Tranmer are careful researchers. In common with other studies, they find that factors such as age, gender, health, employment status, and family composition have significant effects on happiness. They also obtain some new results - they find, for instance, that people who have been living in the same place for more than 5 years tend to be happier than others. (Presumably it's because they're happy that they haven't moved on.) They find that experience of unemployment causes individuals more misery in areas with low unemployment rates than in places where the unemployment is more common.

Since some places are, and others are not, populated by people with characteristics that tend to make them (relatively) happy, the media has suggested that a league table can be constructed that ranks places. Hence, it is suggested, people from (say) Wrexham might consider moving to (say) Wycombe to become happier. But Ballas and Tranmer clearly state that only 'a very small proportion of the variation of the wellbeing measure is attributable to the district level'. Differences between places can be identified, but, once the researchers control for individuals' characteristics, these are not (apart from a very few extreme cases) statistically significant. This is unsurprising - the British Household Panel Survey, on which the results are based, is a very small survey to use when employing a detailed level of geographical disaggregation.

It is the people who make the place. Perhaps, with the housing market being so sluggish, we should welcome the news that we don't, after all, need to move to be happy.

The Nationwide Building Society has announced that house prices have fallen by over 10% in the last year. This is a dramatic adjustment, but it is likely that the collapse in house prices will not end there.

How much further prices will fall is a matter of conjecture. It will depend in part on how vendors, who may be caught in a negative equity situation (where they owe more on their houses than their houses are worth), react. Many may choose to tough out the slump. In this case, houses will stay on the market for a long time, but prices will not fall much further. The recovery in house prices, when it comes, will be slowed down as a result of the stockpile of houses still for sale.

Other factors come into play too. At the moment, with inflation running at over 4% and rising, there is not much immediate scope for interest rate cuts. But the oil price has fallen quite sharply in recent weeks, and there are reasons to hope and believe that inflation will ease off by the end of the year. If interest rates fall, demand for housing could be stimulated, and that could buoy up the market somewhat.

My guess is that house prices will fall, on average, by about 15% in total before they start to recover. And the recovery will be a long drawn out affair. It may be several years before your house is again worth what it was worth a year ago.

A recent report by the World Health Organisation draws attention to the sharp international differences in life expectancy. Not surprisingly, people in rich countries tend to live longer, on average, than people in poor countries. More surprising, perhaps, are the differences within countries - and even within cities. The contrast between two areas of Glasgow has hit the headlines - in one, life expectancy at birth is 82 years for boys, while in the other it is just 54 years. People in both areas have access to the same national health service and face the same environmental conditions. These are shocking statistics.

The figures are explained in part by the tendency for people to self-select into certain residential areas. Calton, where a high proportion of housing is owned by housing associations, tends to attract people who are economically disadvantaged - those in receipt of housing benefit and likely to live in rented accommodation. Relatively poor people have less opportunity than richer people to be well nourished; so much is obvious. There are high levels of heroin abuse and prostitution - both of which are activities that attract people who are at high risk of experiencing health problems to live in the area. (You go where you can buy the drugs; you go where you can work.) Meanwhile, house prices in Lenzie ensure that only those who are economically advantaged can afford to live there.

For a given person, therefore, living in one area or the other may not make all that much difference. But the gaps between the rich and poor are huge. The right investment in our poorer areas could yield a massive social and economic return - through people living longer and working more.

It would be difficult to view the jump in inflation, now up to an annual rate of 4.4%, as anything but bad news. While some analysts are suggesting (or hoping?) that this is a blip and that the rate will start to fall again by the end of this year, the danger now is very real that a wage-price spiral could be set in motion.

A critical difference between now and the 1970s could be position of trade unions. Union membership has collapsed over the last couple of decades, following a raft of legislative measures brought in by the Thatcher government to reduce the impact of trade union power and influence. The levels of price inflation that we are now seeing provide a real test of the effectiveness of these measures. If wage pressure can be contained, then there is certainly the prospect that inflation could fall back quite quickly. But this will depend on the ability of employers to resist wage demands. This, in turn, depends on the strength in practice of the policies introduced a generation ago. While those policies give some grounds for optimism, they haven't been tested in a period of stagflation before now. So inflation may be blipping - but I'm cautious enough to keep an open mind about that. If it turns out to be a more chronic problem, a return to the 'cold turkey' policy prescription of the early 1980s - unpleasant though that would be - may have to be on the cards.

Several large internet service providers (ISPs) have reached an agreement to work with the music industry to deter illegal file sharing. The issue of file sharing has generated controversy over the last decade (almost), since Napster was set up in June 1999. Napster did not introduce any new principles - for many years music fans had been exchanging tapes, itself a breach of copyright law. But the arrival of digital technologies did mean that such practices could become very widespread, with each sharer making files available to millions of other computer users. At this point, the music industry clearly faced a significant new challenge.

The economics of all this are not clear cut. The creators of any intellectual or creative property need protection in order to ensure that they receive sufficient incentive to produce. On the other hand, consumers are clearly better off if they can access music at little (or no) cost than if they cannot. Once the music has been created, it is economically efficient for file sharing to take place.

The catch, of course, is that if musicians and the industry that supports them do not receive remuneration then they will not have the incentive to continue to produce new music. So there is a need for some protection. That is exactly what copyright laws (and, for inventors, patent laws) are there to do. The problem with the law, however, is that it has not kept pace with changes in technology.

Nor can it. Napster was replaced by a host of programs based on smaller *nap networks, gnutella, and torrents. The creative community of computer users is likely to remain at least one step ahead of the legislators. Yet the music industry still seems to be set on using old legislative technology to combat the new threat. Many would claim that it has also shot itself in the foot by charging too much for legal downloads and by adopting an unworkable position on digital rights management.

Now that the music industry is at last working with the ISPs, a far more effective system would be based on the recognition that file sharing happens and will continue to happen. ISPs could agree to charge their customers an additional amount per month, with this being transferred to the music industry. If ISPs do not agree, then this is a system that could be enforced by government. Better government involves itself in this way than by tinkering with laws that are doomed to fail.

It would then be for the industry itself to devise a new way of remunerating musicians using the monies they receive from the ISPs - but it would need to be one that ensures that creative talent is remunerated sufficiently well to keep it creating. Indeed a little redistribution from the superstars towards the support of new talent might well be regarded as a good thing.

This proposal might penalise internet users who do not share files. But it is already the case that light internet users pay as much as heavy users, so inequities are already there. Of course, it would be possible to iron these out by extending the use of charging per byte. That is for the ISPs to decide.

There is nothing particularly new in this proposal - something similar has been used for decades in the context of written works that can be photocopied, where the Authors' Licensing and Collecting Society has made sophisticated arrangements with users. In the context of music, it has been proposed by numerous economists over the last decade. It would be nice to think that the music industry and ISPs might at last be ready to listen.

The Treasury is considering a rewrite of its own rules on fiscal prudence, in order to allow itself to raise national debt above 40% of national income. There are two interpretations of why this relaxation of the rules is necessary. First, the government would otherwise struggle to meet its expenditure commitments, since tax revenues are falling as the economy slows down. Secondly, the slowdown itself needs to be countered by a fresh injection of government spending, and borrowing is the primary means of financing this.

It has become clear that the government has run ahead of itself in terms of its spending commitments. During the boom years it should have spent less, and paid back more of the national debt. Unfortunately, though, the time to cut back has passed. Nonetheless, when the economy starts to pull out of the downturn, it will become necessary for the government to reassess its spending. Expect some retrenchment at that time (probably after the next election) - and consequently a slow bounce-back from the downturn.

The Federal National Mortgage Association ('Fannie Mae) and Federal Home Loan Mortgage Corporation ('Freddie Mac') are two government sponsored but privately owned corporations in the United States, both of which are heavily involved in the housing market. Fannie Mae makes loans and provides loan guarantees, and thus underwrites much lending activity. Freddie Mac buys mortgage debt from banks, repackages it, and sell it as securities to investors. The consequences of either company failing would be catastrophic to the economy. The value of shares in both firms almost halved over the last week, following fears about their ability to raise sufficient funds to continue their operations - a ramification of the current credit crunch. This has led to the US government putting forward a package to support both companies that would involve huge government lending to the firms and also bolstering of their share prices.

As long as 5 years ago, Greg Mankiw highlighted the risk that comes from having such firms buoyed up by implicit subsidies. These subsidies come from the knowledge that the companies are too important to be allowed to fail, and the existence of the subsidies encourages an inappropriate degree of risk taking by the companies themselves. Now it seems that the chickens are home to roost.

The Bank of England has held the interest rate at 5% this month. In the wake of several indications that the economy is weakening and that a recession looks increasingly likely this may seem perverse. But inflation remains well above target, and the maintenance of stable inflation is the bank's main role in setting interest rates.

So long as inflation does not get built into wage increases (and there's a big 'if' in there), it should fall back over the next few months. If this happens, there may be scope for interest rates to be cut again later in the year in order to ease the impact of the downturn. The Bank faces an unenviable quandary - they can't cut interest rates now for fear of stoking inflation, but they should not leave the next cut too late.

House prices fell by 0.9% in June, following a 2.5% fall in May, according to figures released by Nationwide. This is the first tentative evidence that the fall in prices is slowing down - but 0.9% is still a big fall in one month, and the fall might have been even more pronounced were it not for the fact that trading is slow, with mortgage approvals substantially down on this time last year.

When house prices adjust downwards, they can either fall dramatically for a short time, or fall more modestly for longer. They have already fallen by over 6% over the last year, and it looks as though they will keep falling until they are at least 10 or 15% lower than they were at their peak. That's a substantial fall, but even after that we might expect the recovery to be slow. Between 2000 and 2006 the average house price divided by GDP per capita rose from 4.6 to 8.0, and this suggests that the drop in house prices needs to be sustained as well as pronounced.

What does this imply for the wider economy? As the value of people's houses stagnates, wealth declines. People's access to credit declines, and so consumption is likely to be less buoyant than in the recent past. In other words, the outlook remains one of economic slowdown - despite the rising oil and food prices. We've had some good years, but at the moment economics is earning its 'dismal science' moniker.

Inflation has risen above the 3% mark, and Bank of England governor, Mervyn King, will have to write a letter of explanation to the Chancellor of the Exchequer, Alistair Darling. Indeed, the increase, to 3.3% is higher than most pundits expected. It is not too difficult to find explanations, but it is somewhat harder to find fixes. As we all know, prices of oil and foodstuffs have risen dramatically owing to international conditions.

The policy tool that is available to the central bank is the headline rate of interest. Hiking the rate of interest reduces demand and so puts downward pressure on prices. The trouble is that the general condition of the economy is not one in which interest rate hikes are a particularly attractive option. This is because, by reducing demand, they would make a recession - which already looks to be more than a remote possibility - increasingly likely, and all the more severe.

Faced by the threat of both inflation and unemployment, government needs to use more than one policy tool. The obvious second tool to use is fiscal policy - interest rates could then be used to control inflation while raising the government's budget deficit could ensure that the consequences for employment and growth are not too adverse.

The problem with this is that the government's budget deficit is already large. Indeed, as a share of GDP, it is larger than that of any other major country except Hungary and Pakistan. The scope for extra borrowing to be effective is limited therefore. People would know that the borrowing would have to be paid back out of future taxes, they would start saving up for those heavier tax burdens, and the demand taken out of the economy by these extra savings would cancel out much of the benefit of the extra demand generated by the borrowing. That said, the government did recently inject an extra £2.7 billion into the economy as a means of defusing the political revolt over the abolition of the 10% rate of income tax.

A stronger candidate for second policy tool, as things stand, is for the government to operate directly on people's expectations of inflation. The price increases of the last year have been pronounced, but they will become truly inflationary only if wage settlements are raised in line with (or ahead of) the increases in prices. To keep inflation down, wage deals need to be kept at levels that are sufficiently modest to ensure that we do not enter a wage-price spiral.

I am not advocating an incomes policy here. Such policies have, in the past, tended to be ad hoc and so have typically failed after a couple of years. But there is much to be gained from senior and credible politicians stating the facts clearly. Prices have risen. This is because there are now more people competing to consume the finite supplies of oil, and there are more competing uses for the produce of agriculture. We can catch up with the purchasing power that we had a year or so ago by becoming more productive. We can't catch up by giving ourselves pay deals that just wind up pushing prices up further. In particular, a monetary policy that simply involves printing more money to accommodate inflation - repeating the mistakes of the 1970s - is (or at least it should be) a non-starter.

It's time for the politicians to talk tough reality.

There has been a lot in the news lately about anti-competitive practice. Today, tobacco manufacturers and retailers are accused of price co-ordination. Last week, construction companies were accused of collusion in securing tenders.

Anti-competitive practices are subject to regulation because they can serve to reduce economic welfare. While companies engage in such practices in order to increase their profits, this increase in profit is achieved by exploiting their trading partners. In many cases, the exploited lose more than the exploiter gains. So on balance, the anti-competitive behaviour is a bad thing.

How is it that the exploited lose more than the exploiter gains? The gain in profit is usually achieved by raising prices; when they do this, firms find that they can sell less output. The increased price for which each unit is sold more than compensates them for the fact that they are selling fewer units. For the consumer, however, not only is less consumed, but more is paid for each unit that is still consumed.

The news about tobacco is not particularly surprising. The news about collusion amongst construction companies is more so - because of the sheer number of firms alleged to have been involved. Collusion between large numbers of companies is rare. This is because each firm has an incentive to cheat on the deal, and it is difficult to be caught cheating when there are many companies involved.

The Bank of England has today cut the interest rate by a further quarter point to 5%. This is intended to stimulate the economy in the face of the anticipated downturn. The question is: will this be enough of a cut for a while, or can we expect further cuts in the months ahead?

The first thing to observe is that the Bank's interest rate is having a less focused impact on the real economy these days than has been the case in the past. While the Bank has been cutting the interest rate at which it lends to other banks, the squeeze on credit has meant that the interest rates that people pay on their mortgages (and that businesses pay on their borrowing) have not come down. The Bank's decision to cut its interest rate today is good news in that it might prevent the cost of mortgages rising, or it might ensure that more mortgages are available. It is also good news in that sometime, further on down the road (who knows when?), the cost of mortgages should come down - and this will give a boost to the economy.

At the same time, oil prices have reached another record high, and the consequent effect on prices more generally needs to be heeded. The threat of inflation may be sufficient to render any future cuts in the interest rate less likely.

But we are in a 'play it by ear' situation. The very least that can be said for economic policy at the moment is that it is interesting.

House prices have fallen by nearly 3% since they hit their peak late last year. Prices are still higher (just) than they were a year ago, but only because of the sustained increase in prices through most of 2007. It now seems likely that the year-on-year rate of house price inflation will turn negative at some point during the current year. The question is: how negative?

A downward adjustment of between 5 and 10 per cent seems to be the likeliest outcome. Prices are currently dampened by the effects of last year's interest rate hikes and the current difficulty that people are experiencing in getting mortgages. But the Bank of England has already cut interest rates, and more cuts are in the offing. These have not, in the main, fed through to mortgage payers yet, owing to nervousness surrounding the credit crunch - but they will. And as confidence returns to the banking sector (which may happen after or, hopefully, without another blip or two), mortgages will become easier to find. A moderate adjustment of house prices, followed by a gradual and modest recovery, would not be comfortable. But neither would it cause much real damage.

Meanwhile, in a fascinating recent study, the International Monetary Fund reckons that house prices in the UK are 27% higher than is justified by the fundamentals. Perhaps. For sure that kind of gap could be fixed either by the 'soft landing' that I have described above or by something more drastic.

A more drastic realignment would introduce problems of negative equity on a large scale - where people find that the value of their house does not cover what they owe as a mortgage, thereby making it difficult for them to move house. This has to be seen as a less likely - but nevertheless possible - outcome than a more moderate readjustment.

The House of Lords Economic Affairs Committee has today published a report on immigration to the UK. It concludes that the recent wave of immigration has had 'little or no impact' on the economic position of native Britons.

To be sure there are pros and cons of migration. The sharp increase in population that has resulted in certain parts of the country has put (upward) pressure on house prices and local services. It has also put (downward) pressure on wages, particularly at the bottom end of the labour market. However, this last fact has meant that it has been possible to sustain relatively high levels of growth, and so maintain low levels of unemployment, without setting off inflation. This has been a huge benefit of migration that the Committee seems to underplay.

A further benefit is that when a downturn comes, much of the impact can be absorbed by migrants returning to their home countries. We may already have seen the start of this process, as movements of workers from Britain to Poland are reported, in the last couple of months, to have exceeded those in the other direction.

Migration has already given us growth we could not otherwise have enjoyed. Over the next couple of years, we face a serious downturn if not a serious recession. Migration is our biggest source of hope that the impact of that downturn will be moderate.

The collapse, and subsequent takeover by JPMorgan Chase, of Bear Stearns investment bank has sent more shock waves resonating around the world's economies. The climate in the banking sector is clearly one of fear. Banks, which routinely lend to each other on a daily basis, are no longer doing so - so fearful are they that today's loans could turn out to be tomorrow's bad debts.

In a move designed to ease these fears, the Fed has already cut the rate at which it lends money to commercial banks, and is expected to cut the more general interest rate (yet again) tomorrow. Whether these interest rate cuts will work or not is moot, however - the worries are about whether loans will be repaid at all, not about how much interest is charged on the loans. In this context, the discount rate cut is a tinkering at the margins. (That's not to say that the economies of the US and UK don't need interest rate cuts to ease fears of recession - they do, but that's a slightly different albeit not altogether unrelated matter.)

More radical moves are under way with the coordinated approach of several central banks to ensure that loans can be made to the banking sector. The Fed is making up to $200 billion available, the European Central Bank up to $15 billion. The Bank of England is making £11.35 billion available as 6, 9 and 12 month maturity repurchase agreements (repos). The question is: will this be enough, or does the fact that the central banks are doing this just serve to make the whole system yet more nervy?

In light of the fact that inflationary pressures are still present, while the economy is turning down, it is clear that separate policy instruments are needed to ensure that the objectives of low inflation and high employment are met. In the recent past, monetary policy, in the form of interest rate adjustments, has been much to the fore. The announcement in today's budget that fiscal policy will be used to bolster the economy is therefore welcome.

Borrowing by government will rise to £43 billion over the next year. The government remains committed, however, to keeping to its 'golden rule' that borrowing for current expenditures should be neutral over the business cycle. This being so, the government projects that its budget deficit will fall in subsequent years.

Growth forecasts have been adjusted downwards, but the government is still anticipating growth of 2% (give or take 0.25%) this year. It expects a growth to pick up next year. This seems optimistic, and a delayed recovery could threaten adherence to the 'golden rule'. But the threat of recession now is quite severe, and it seems appropriate that - whether the 'golden rule' is met or not over the course of this cycle - fiscal actions should be taken to bolster the economy at this time.

An interesting story has broken today about the antacid medicine Gaviscon. The patent on this drug ran out several years ago, but Reckitt, which manufactures the product, has effectively precluded the marketing of generic equivalents by objecting to suggestions put forward for a name by which the unbranded product can be known. This has allowed Reckitt to sustain profits, but has cost the National Health Service (or, more accurately, the taxpayer) millions of pounds that could have been saved if an unbranded equivalent had been available.

Patents exist to give innovating companies protection from competition for a limited period. If there were no patents, companies would be reluctant to invest in research and development because imitators would come along and reduce the profits that the innovating company has earned as a result of its research. So it is right that patent protection should be available.

For a company to attempt to extend monopoly power beyond the life of a patent is understandable - it gains extra profits if it is successful in doing so. But this does also deny society the benefits of competition.

What really beggars belief about this story is that the authorities have allowed prevarication about the name of a generic product to go on for years. It is this failure to get to grips with an issue that has really been costly.

Northern Rock is in the news again. The government has decided that a 'temporary' nationalisation of the company is the best route forward. Whether they are right or not remains to be seen.

The economic literature on auctions has highlighted the existence of something known as the 'winner's curse'. In any bidding war, it is usual for some bidders to underestimate the value of the lot, while others overestimate it. By choosing the nationalisation option, the government is implicitly suggesting that the various private sector bidders for Northern Rock were all undervaluing the company, and were therefore not willing to bid enough for it.

Perhaps the government is right. But equally, perhaps the government has got its own sums wrong. After all, while there were only two players in the game at the end, other private sector bidders had pulled out much earlier. Could it be that they were all wrong? Or is it more likely that the government's estimates of the financial commitment that will be needed to bail out the Rock will prove to be overly optimistic?

I was reading a fascinating paper by Eli Berman and David Laitin last week. This suggests that terrorists' choice of method - overt insurgency or suicide attacks - depends upon a number of factors. These include the terrain (with insurgency being favoured in mountainous areas), the extent to which an attack might be expected (with insurgency being favoured if the attack is a surprise), and with the level of resourcing of the security services (with surprise attacks likely being more successful than overt insurgency where there is generous resourcing).

In Iraq, overt insurgency has been the norm. But over the last month or so, suicide attacks have been getting more common, the latest case being particularly disturbing, involving as it did the use of two mentally disabled women as carriers. The surge, which has improved the resourcing and numbers of US armed forces in Iraq over recent months, has rendered conventional insurgency less fruitful for the terrorists, and this may be what has led them to turn increasingly to suicide attacks as a means of operation.

Just a week after cutting interest rates by 0.75%, the Fed has cut US rates again by 0.5%. The US economy is certainly in need of stimulus. In the last quarter of 2007, growth was barely above zero, and it looks likely that growth will turn negative this quarter.

It is too early yet to assess how the markets have responded to the move. New York markets initially responded well, but by the end of the day have fallen back considerably. The interest rate cut itself is good - the signal it sends about the severity of the malaise to which it is a response is bad news.

In an attempt to avoid further bank runs similar to the Northern Rock experience, it is being proposed that the Bank of England should be able to lend banks money without the loans being made public. There are clear benefits and drawbacks associated with this proposal.

The benefit is that, in the case of Northern Rock, the bank run was precipitated by disclosure of the fact that the company was in sufficient trouble to require special help from the Bank of England. Much in this sphere depends on confidence, and it was disclosure that eroded the public's confidence in the bank. So, the argument goes, take away disclosure and you take away the thing that saps public confidence and causes the bank run.

There are two drawbacks. The first is that taxpayers, if they are to make sensible choices at the ballot box, should know how their money is being spent. If bailouts of banks are to be kept secret, we won't know. So long as disclosure is required after a certain time period has elapsed, this problem need not be severe. The shorter the period, the less serious the problem. But also, the shorter the period, the more likely it is that the bank being helped is not yet out of trouble. Nothing has yet been said about how long this period should be - but it is clearly a crucial issue.

The second drawback is that an information vacuum tends to suck in rumour. This carries the risk that the next victim of a bank run will be an organisation that is financially very secure. The problem is that we need information about banks so that we know that we can trust them - but we need not to have information about banks that might fail. Unfortunately, though, the absence of information would mean that we knew everything that we need to know. Now there's a paradox.

And it implies that the true source of the problem lies elsewhere - in the fundamentals of banks' balance sheets. Tinkering at the edges, making information secret, is cosmetic surgery. The system needs more than that to put things right.

The US Federal Reserve today cut interest rates by 0.75% points. This is a week before the time of the month when the Fed would normally be expected to adjust rates, and has come int he wake of a significant crash in the stock market. Is this a timely and appropriate response to current economic conditions, or does it reflect panic?

Curiously, the answer is both. For the Fed walks a tightrope in deciding by how much to cut rates. Clearly the American economy is in dire need of a big stimulus. But the bigger the stimulus, the clearer the signal that things are not going well, and the more sapping is the effect on consumer confidence - and hence on spending. It is not yet clear on which side of the tightrope the Fed has trodden today - or whether it has got things exactly right.

The markets have got the jitters. Actually that's something of an understatement, with the FTSE having experienced its largest one-day drop since 9/11 yesterday. The panic amongst equity sellers is fuelled by fears of a recession in the US - something that I have been flagging on this blog for many months now. The signs are that the American economy is heading for a sharp reverse. While some of the more complacent observers note that the UK economy is in better shape (and indeed it is), the old adage that when America sneezes the rest of the world catches a cold remains true - at least when America sneezes with the kind of gusto that one can expect now.

As recently as this weekend, the Telegraph was arguing that higher interest rates should be the order of the day in the UK. It is certainly the case that inflation is a threat - given higher fuel and food prices. But, so long as wage pressure can be contained, the much more serious threat is recession. To stave off this threat, it is likely that both further interest rate cuts and a fiscal injection (an increase in the government's budget deficit) will be necessary. There are some (really) tough times ahead.

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.