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.