Mervyn King, the Governor of the Bank of England, once declared an ambition to be boring. He meant that the conduct of monetary policy should be so smooth as to be unobtrusive. Mr King has fallen far short of that objective by quite suddenly being very interesting indeed.

Throughout her reign, the Queen had never held an audience with a governor of the Bank – till yesterday, when she met Mr King. The meeting might have passed as a constitutional idiosyncrasy, but Mr King also appeared to diverge from the policies of the Prime Minister. Appearing before the Treasury Select Committee of MPs, he was sceptical about the scope for further stimulus of the UK economy by fiscal means. Given the size of the deficits now and for the next two to three years, argued Mr King, there should be caution about adding to them.

Mr King’s economic assessment is at odds with that of the Government. Yet he felt unconstrained in saying it anyway, on the same day that Gordon Brown spoke before European MEPs in Strasbourg. The Prime Minister has been careful to avoid explicit commitments to additional fiscal stimulus. But his identification with the economic programme of the Obama Administration, and his message that Europe must take a leading role in countering the economic downturn, put him in the camp of fiscal activism in principle.

Mr King was thus right and timely in his message. The recession needs to be countered by radical measures to stimulate demand. But monetary policy must be the principal means of stabilising the economy. Fiscal profligacy by the Government since well before the last election has sharply constrained the ability of UK policymakers to borrow and spend more.

The Government was understandably swift to dispute any suggestion of a breach. Yvette Cooper, the Chief Secretary to the Treasury, rationalised brightly: “What [Mr King] said is we need to take a sensible approach, which we always do.”

When commenting on policy, public servants are always aware of the political implications of what they say; they would not otherwise survive long in office. Some degree of interpretation of their comments is usually necessary. But the implications of Mr King’s remarks are not obscure at all. Had the Government always taken a sensible approach to the management of public finances, then there would be no need to urge a sensible fiscal policy. Sober and financially literate observers have expressed concerns in literally apocalyptic language. Steve Bundred, chief executive of the Audit Commission, has written in this newspaper of the risk of an “Arma-geddon scenario”, where there are not enough lenders to meet planned levels of public borrowing. The CBI, whose members are suffering from a precipitate collapse in demand, has said that there is no room for fiscal stimulus “of any kind” in Alistair Darling’s Budget next month.

Mr Brown has long positioned himself as a politician of ideas as well as instincts. He follows theoretical debates, not least in economics – the policy area with which he is most closely identified. In his Strasbourg speech, he was at pains to contrast the prospect of a “new principled economy for our times” with what he dismissively referred to as the old Washington consensus. The implication is that the huge financial and economic ructions of today demonstrate the obsolescence of free-market dogmatism of yesteryear.

Yet as Chancellor and Prime Minister, Mr Brown has abandoned more than just some fusty and anachronistic doctrines of markets that find their own equilibrium. He has ignored some of the cardinal principles of Keynesian economic management. Keynes’s central insight was that a market economy is prone to cyclical instability. Active monetary and fiscal measures are needed to stabilise the economy. In fiscal policy, that means that governments should build up surplus-es during an economic expansion, so that there is scope to support demand by running deficits (beyond those that would automatically arise from slower economic activity) during a downturn.

This approach was followed when Labour took office in 1997. In Tony Blair’s phrase, the party had been elected as new Labour and it governed as new Labour. In its first two years, the Government accepted the spending plans of the previous Conservative Government. Total managed expenditure in 1999-2000, at 37.7 per cent of GDP, was lower than at any time since the early 1960s. That discipline has been not so much abandoned as dropped down an Orwellian memory hole.

The International Monetary Fund observes that the budget deficit is set to reach 11 per cent of GDP in 2010, a postwar record. In a recession, deficits arise because of a reduction in personal and corporate tax receipts and an increase in welfare payments. But the scale of additional borrowing to counter the downturn carries huge risks. At some point international investors will make a judgment on the creditworthiness of UK sovereign debt – and balk.

Mr King is right, therefore, to stress that monetary policy must be the principal means of stimulating demand further and ensuring that the economy does not succumb to a spiral of declines in prices, output, investment and employment. That means persisting with low levels of interest rates and expansion of the money supply by buying corporate and government debt. But that route has been complicated by the release yesterday of new figures for inflation.

The annual rate of inflation, as measured by the retail prices index (RPI), is now zero. The RPI includes housing costs. As interest rates have been slashed, these costs have fallen sharply. But on the measure the Government has chosen to target – the consumer prices index – inflation is accelerating, owing mainly to higher food prices. The annual rate of inflation on this measure unexpectedly rose in February, from 3 per cent to 3.2 per cent – well above the Government’s target. The pound strengthened on the news yesterday, anticipating an earlier return to more normal levels of interest rates.

The conduct of monetary policy is thus being complicated by mixed signals. To interpret these signals correctly is especially important when further fiscal stimulus is so far from being sensible. The Bank of England faces an exceptionally testing challenge. Nothing will prevent a painful recession for 2009. But the right decisions taken now may make the difference between a short “V-shaped” recession or – as happened in Japan in the 1990s – a prolonged “L-shaped” recession, where the economy fails to respond to remedial measures.

Not only must the Bank get the decision right in extraordinary economic times, it must also, in effect, compensate for the failures of the Government’s fiscal management. That is why Mr King is right in what he says, and justified in saying it.

One historian a few years ago described the Bank of England as manifestly the money-printing wing of the Treasury. That role was decisively established almost a century ago, when the Bank unwisely impeded the Government – during wartime – from gaining access to official gold reserves. The governor of the time wrote a humbled letter to Andrew Bonar Law, the Chancellor, pledging to “work loyally and harmoniously” with him. It has taken extraordinary times and unabashed economic mismanagement for the Old Lady of Threadneedle Street to stir. Mr King’s cautionary words are nuanced and devoid of drama. But they are a cogent critique of failure, which the Government must now heed.