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.