Gordon Brown must soon take one of the most important decisions of his political life. Before he takes the plunge he must carefully assess recent events, consider the state of the economy and think about his personal reputation. Having weighed up all these factors, he must then take a lonely decision: either he must dismantle his economic policy framework or he must stop blaming the Bank of England for Northern Rock. The Northern Rock crisis may have slipped off the front pages but, to judge by the corridor chat in Bournemouth, its political effects have only just begun.

Suddenly, the concept of Bank of England independence, an unquestionable dogma regarded unanimously as the bedrock of Labour’s economic achievements, seemed almost like an historic relic, as passé as Alastair Campbell or the Blair-Brown feud. Discussing the prospects for the general election, Labour backbenchers sounded like liberated religious cultists, suddenly freed to return to the old patterns of thought that were brainwashed out of them ten years ago.

You know the sort of thing: “If Gordon waits until next year for the election, we can be sure of some rate cuts before polling day”, or “If there’s a problem with house prices, Gordon will fix it with lower mortgage rates”. Such coarsely manipulative language is not yet, of course, to be heard from senior politicians. Ministers still treat monetary independence as officially sacrosanct; but then they quickly change the subject to the need for a shake-up after the Bank’s regulatory failings.

This may seem reasonable after the Northern Rock crisis, but think about the present context. For the past three weeks, the media have been full of barbed comments, presumably based on government sources, about the Bank’s incompetence. Ministers may not have started rumours that Mervyn King had lost his chances of reappointment as Governor, but they have done nothing to stop them. What is now under attack, therefore, is not just the Bank’s regulatory operation, but the competence of the whole organisation, including the man at the top.

The question logically implied by this campaign is how can this dysfunctional organisation be given control over something as important as the setting of interest rates?

In saying this, I do not wish to imply that the Bank of England or its Governor should never be criticised or challenged. A central bank is prone to human error and the people who run it must be made to acknowledge and learn from their mistakes. It is perfectly appropriate to challenge Mr King’s technical decisions on long-term loans to the British banking system, to question his approach to moral hazard or dispute his rather unworldly arguments about the division of responsibilities for bank regulation. But where should such criticisms lead?

Criticisms of the Bank of England, if politicians genuinely want to retain popular support for its independence, have to be policy-orientated and constructive, not destructive and ad hominem. It is obvious that Britain needs urgent action on a new deposit insurance scheme, but beyond that the Northern Rock crisis raises difficult questions that require serious policy debate, not a personalised witch-hunt. The main policy question is whether responsibility for supporting the banking system should be shifted from the Bank of England to the Financial Services Authority and the Treasury. This idea seems appealing – and appears to be the Government’s favoured option. The Bank could then concentrate on its essential function of setting interest rates and managing inflation, while FSA officials who took over bank lending would be directly responsible to the Treasury for the costs of regulatory failures such as Northern Rock.

Logical though it sounds, such a reform would raise many problems, which mostly revolve around a simple question: how would this slimmed-down Bank of England put its decisions into effect? Interest rates are not set by ex cathedra pronouncements. To keep interest rates at the levels they deem appropriate, central banks must trade billions of pounds, dollars or euros in the money markets every day.

If these money-market operations were shifted to the FSA or the Treasury, the Bank of England would quickly turn into a pure economic think-tank with no independent power. Real responsibility for managing interest rates would revert to the Treasury, effectively reversing the reforms of 1997. What, then, if the Bank retained its money-market operations, but handed them over to the FSA and the Treasury in periods of financial stress? What this would mean in practice is the Bank losing its autonomy in periods of crisis, which is exactly when independence matters most.

What, then, is to be done? A different approach – in fact exactly the opposite to the one that ministers seem to favour – deserves equal consideration. Instead of removing the Bank completely from crisis management, Britain could follow the US example and increase its supervisory role. The Bank could be forced to beef up its regulatory operations and reestablish the deep knowledge of individuals banks and bankers that was once its boast. If the Bank did this, it would duplicate the FSA’s functions, but why not?

Duplication is taken for granted in America, where five separate government bodies – the Federal Reserve, the Treasury, the Federal Deposit Insurance Corporation, the Comptroller of the Currency, the Securities and Exchange Commission – each have deep knowledge of banking problems. This may seem inefficient, but the organisational overlap does at least guarantee the constructive and well-informed institutional debate that was notably absent over Northern Rock.

As for the question “Who is in charge?”, which caused bafflement to Mr King last week, the US model provides a sensible answer: each institution has its own job to do, but ultimate responsibility for coordinating the response to any serious crisis – and for reassuring the public – must rest with the country’s most senior, respected and impartial public official. That means the head of the central bank.

This final point brings me back to where I started. In almost every modern economy, the central bank is the most respected public institution. It has to be, because central bank independence is only politically acceptable in a democracy if the institution and the people who run it enjoy widespread confidence and support.

In Britain this confidence is now being badly shaken, not so much by the Northern Rock crisis, which the public blames mostly on the company’s own management, but by the ensuing bureaucratic backbiting. Mr Brown must therefore make a decision: either he must stop his colleagues undermining the Bank of England and the people who run it; or he must start to dismantle the entire economic framework based on central bank independence, which he built in 1997. That is the really important choice the Prime Minister must make in the next few weeks.

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