At last, Gordon Brown has done something right. By reappointing Mervyn King for a second five-year term as Governor of the Bank of England, Mr Brown has taken his first sensible economic decision since he became Prime Minister. Keeping a steady and experienced hand on the monetary tiller will not guarantee plain sailing, as the Bank tries to steer Britain through the worst bout of economic turbulence since the early 1990s; but at least Mr Brown has avoided making a bad situation much worse.

Just imagine what would have happened to Britain's new-found image of economic stability if the Governor had not been reappointed. Our tax structure has been in a state of upheaval since October's pre-election mini-Budget. Public spending has been out of control for the past three years and, with tax revenues from the City and the housing markets suddenly vanishing, the Treasury's public borrowing targets have been falling like ninepins. And that was before the decision to blow apart Mr Brown's entire “fiscal framework” by offering £55 billion in government-guaranteed loans to Northern Rock.

Now suppose that new Labour's approach to monetary decision-making, based on the independence of the Bank of England, was also demolished by effectively sacking the Governor. Mr Brown's entire economic policy, built around the fiscal and monetary “frameworks”, would have been reduced to rubble. His reputation for economic competence would have been completely shot - even before the public started to feel any real hardships from the impending slowdown and housing slump.

Under these circumstances, the only surprising feature of Mr King's reappointment was that it was so long in coming. We will probably never know whether the timing of yesterday's announcement was dictated by some small calculation of tactical advantage or whether Mr Brown really found it difficult to make up his mind about what must have been one of the easiest decisions a prime minister has ever faced.

In any case, what matters now is that the Bank's Monetary Policy Committee can now set interest rates again without having to worry about political interference, whether in reality or in appearance. As a result, the MPC can - and should - start cutting interest rates much more aggressively than it has done so far in response to the global economic slowdown and credit crunch. While it may be too much to expect the Bank to follow the US Federal Reserve Board and slash interest rates by 1.25 per cent in a single month, the quarter-point rate cut widely expected from next week's MPC meeting seems woefully inadequate, given that prospects for the British economy are probably worse than for America in the year ahead.

While uncertainty about the Governor's fate was hanging like a Sword of Damocles over the Bank's independence, it may have been reasonable for the MPC to tread cautiously and avoid any possible appearance of political motivation in easing interest rates. Now that this issue has been settled, the MPC can immediately start cutting interest rates in half-point or even full-point slices.

The lifting of uncertainty about the Bank's political independence has an even more important implication for the personal role of the Governor. Mr King can - and should - now resume traditional responsibilities of the Governor that were somewhat neglected in his first term. He should not only act as Britain's most authoritative spokesman on monetary matters, but also as the Government's most senior adviser on financial matters generally and especially on the management of financial crises.

In doing this, Mr King should recognise the one big mistake of his first term. As the Northern Rock fiasco clearly revealed, the Governor acted too radically in transforming the Bank of England from a multifaceted financial institution with deep experience of the markets into a quasi-academic monetary think-tank. In the process, the Bank abandoned its crucial function as the Government's “eyes and ears” in financial markets, along with its role as an independent arbitrator in large-scale financial rescues.

While Mr King cannot and should not try to restore all the Bank's old supervisory functions, still less its role as an official spokesman for City interests, he does need to recognise that there will be much more overlap in future between monetary decision-making, financial regulation and economic policy generally than he had assumed in his first term. The obvious issue with which to begin this process of recognition is Northern Rock.

Northern Rock is an issue on which Mr King must speak out clearly, partly because this crisis was triggered by his own rather idiosyncratic attitudes to the moral hazard of offering support to imprudent banks. Now that Mr Brown has decided, for essentially political reasons, to turn Northern Rock into the most expensive industrial support operation yet undertaken by a British government, Mr King must recognise that whatever costs ultimately fall on taxpayers will permanently stain the Bank's reputation as well as his own. He should also recognise that this rescue has now been so politicised by the Prime Minister and the Treasury that the Bank is the only government body that can represent the public interest in an authoritative way.

Mr King should state categorically that there is no possible justification for using £55 billion in government guarantees to keep this one small company in business. He should then explain that there is a perfectly good alternative: that is to wind up Northern Rock and immediately pay off all depositors, while gradually recouping the Government's loans to the company as mortgages are repaid or gradually sold off.

He should point out that the Government's rescue plan for Northern Rock - at a cost of more than £9 million for every job secured - completely contradicts the Bank's opposition to offering banks and their shareholders ex-post insurance for reckless lending, that it rides roughshod over all the competitive principles the Government has ruthlessly applied to manufacturing and other industrial sectors. He should add that providing government guarantees to keep Northern Rock in business as a going concern is totally incompatible with EU state aid rules - and that any politically motivated decision by the Commission to approve this operation would discredit all Britain's efforts to ensure proper enforcement of single market rules by the EU.

As the Government's chief financial adviser, Mr King must first say all these things to the Prime Minister privately. But if the Prime Minister fails to listen, Mr King must speak out on these matters publicly, making his opposition to this politically motivated profligacy with public money unmistakably clear. Now that he has been reappointed, the Governor can focus on serving the country - and not just the government of the day.

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