Jermey Warner's Outlook: Why all the fuss about the Bank's deputy? Inflation is the enemy now, not the crunch

If there is indeed a battle raging between the Bank of England and the Treasury over who should replace Rachel Lomax as deputy governor, it is a pointless one which powerfully supports the contention that the Government has lost the plot over the management of the economy.

The genesis of this story is a letter written last week by George Osborne, the Shadow Chancellor, demanding that Sir John Gieve, the other deputy governor, be moved into the Lomax position so as to make way for a City heavyweight to take charge of financial supervision and stability.

Rightly or wrongly, the Bank of England has been criticised for its handling of both the Northern Rock debacle and the wider credit crunch. Since the function of banking supervision was removed from the Bank and vested in the Financial Services Authority, the Bank is said to have neglected its wider responsibility for financial stability, resulting in failure adequately to appreciate the dangers posed by credit markets and inept handling of the crisis when it broke.

What's needed, the argument goes, is someone with real City knowledge to restore the Bank's authority in financial markets and to act as a better early-warning system.

There may be merit in the idea that the Bank of England should be given back more responsibility for financial oversight. As I understand it, this is what the Tories are demanding. There's a second consultation document due to be issued by the Treasury later this month which should give an insight into the Government's thinking on these matters.

Yet the idea that the issue can somehow be settled through the choice of Ms Lomax's successor misses the point. The debate about how to redesign the regulatory framework to make it more effective is no doubt a necessary one, but it is also yesterday's war. The credit crisis has already happened. Changes will eventually get pushed through which may or may not improve matters.

Meanwhile, the Bank of England faces rather more pressing challenges in what, since being granted independence, has been its core function – controlling inflation. Mervyn King, the Governor of the Bank of England, is therefore entirely right to insist that the position being vacated by Rachel Lomax – the deputy governorship responsible for monetary policy – should go to an established expert in this field.

A City grandee would be entirely wrong for this position. It would also be a backward-looking appointment which addressed the supposed failures of the past rather than the challenges of the future.

Mervyn King's preferred choice is said to be Charlie Bean, his chief economist. This would be the same career path as Mr King himself took en route to the top. The Governor might reasonably be accused, then, of trying to choose his own successor, but that's a rather different issue.

The only other credible internal candidate for the job is Paul Tucker, the Bank director with responsibility for markets, but also, given how long he has been at the Bank of England, a presumed expert on monetary policy. Whether it is Mr Bean, Mr Tucker, or a suitably qualified outside economist, doesn't seem to me to matter very much.

What does matter is that the Bank once more gets a grip on inflation. This has become a much more pressing matter than the credit crunch, where many of the necessary lessons have been learned and the workout is already under way. Inflation, by contrast, shows every sign of running out of control. The Bank's ability to keep it in check is being questioned by both markets and the general public. Inflationary expectations are rising in both.

Bringing it to heel is going to require tough, painful, and possibly politically unpalatable decision-making. A major test of the Bank's independence is in prospect. It may even mean raising interest rates into the downturn – a repeat of what happened in 1981 when great swaths of British manufacturing industry were wiped out in the monetary austerity of the time.

Mr King has said he doesn't want to provoke a recession by trying to bring inflation back to target too fast, yet he may be left with little option if he doesn't want to be remembered as the Governor who failed both on the credit crunch and with inflation.

In any case, there is something to be said for the short, sharp, shock approach, allowing the economy to purge itself of past sins and begin afresh. Trying to mitigate the pain can lead to years of stagnation, or, as with the way the Fed attempted to head off recession in the aftermath of 9/11, sow the seeds for even worse, future crises. One thing is certain. Inflation left unaddressed will only succeed in returning Britain to its post-war history of economic malaise.