Falling investment has taken over from government spending restraint as the main brake on the economy.

A routine inspection of the UK Treasury's Pocket Data Bank reminded me of the quotation from Hamlet: "There is something rotten in the state of Denmark."

It is no news that the UK is experiencing unbalanced growth. Consumer spending is rising merrily while the export sector languishes. Services are flourishing while manufacturing is in the doldrums. And the explosion of consumer debt is almost a topic of bar-room discussion. Unemployment has started to rise gradually but the chosen inflation measure of Gordon Brown, chancellor of the exchequer, is well below the 2.5 per cent target.

These conflicting indicators predictably produced a conflict at the January meeting of the Bank of England monetary policy committee. Everyone agreed the best course was to make no immediate change. But this covered over a rift between the "hawks" who were expecting - as the financial markets do - a rise in interest rates and the "doves" who looked forward to further cuts.

The UK does indeed now have a consumer debt to income ratio higher than that of the US but about the same as Germany's. No one knows how high the ratio can safely go. Meanwhile lower interest rates and lower inflation have cut the cost of debt servicing.

Consumer spending has been rising faster than real gross domestic product by a substantial amount in every year since 1995, unaffected by the change of government. Until recently a near-standstill in general government expenditure on goods and services helped to make room for the spending boom. But government spending is now recovering and is already increasing faster than real GDP. Fixed investment is on a downswing and has taken over the equilibrating role. Continuing relief from this last source is, however, neither desirable nor likely.

One might expect that with so much domestic spending in the pipeline the pressure would shift to the balance of payments. But you have to penetrate a statistical thicket to see what is going on here. The current balance of payments deficit was £17bn ($24bn) in 2000 and about the same in 2001. As a proportion of the national income it is smaller than deficits recorded in the late 1980s and smaller than the US has been running.

But its composition is inauspicious. The deficit in traded goods is running at about £30bn or more - higher than the late 1980s. There has been an adverse trend in overseas transfers. Both these red ink forces have been offset by an increase in the surplus on services and in overseas investment income. There is nothing wrong with the latter. But it is a highly erratic item, which has varied from around zero to nearly £13bn. It depends on unpredictable factors such as the drop in UK interest payments to overseas sterling holders.

The last public discussion on how much a current payments deficit mattered was in the late 1980s and early 1990s. The tentative conclusion was that it did not matter and could be healthy if it financed a rise in profitable investment that would not otherwise have been possible.

There is a ray of hope here. In both the US and the UK investment increased much faster than GDP. There was no such investment breakaway in virtuous countries such as Germany and France which maintained a balance or surplus on current account. So perhaps the British deficit helped to finance an investment upsurge - now temporarily flagging because of world recession - that will ultimately produce the productivity improvement for which the chancellor hopes.

The middle-of-the-road view, expressed in speeches by Sir Edward George, governor of the Bank of England, is that unbalanced growth is better than no growth. Imbalances eventually cure themselves. The questions are "When?" and "At what cost?" If the UK were part of a single European currency system, the imbalances would express themselves solely through the build-up of debt. An independent exchange rate for sterling does have the advantage, emphasised by the governor, of allowing the Bank to pursue an independent interest rate course. But it has the disadvantage that the economy can be knocked off course by a sterling fall when it is least welcome.

There is, however, a lesson from history. When sterling took a knock after Britain's departure from the exchange rate mechanism in 1992 there were widespread fears of an inflationary backlash, shared, I confess, by myself. This did not occur, doubtless because it was difficult to pass on import price increases to the final customer in a rather depressed economy. The moral is that if and when a sterling crash occurs - an event that would involve a recovery in the moribund euro - the MPC would be wrong to rush in with an interest rate rise because of fears that might never materialise.

But it would be equally rash to rush into further interest rate reductions in the near term simply because of recession expectations that are only slightly borne out by events. It would be ludicrous to take risks with an already unbalanced economy for fear that the chancellor's chosen measure of inflation might fall below 2.5 per cent in the next year or two.

The debate in the MPC illustrates, if nothing else, that neither the inflation target nor the short-term interest rate weapon can bear all the weight now put on them. The mainstream economist's approach to a structural imbalance of the kind faced by the UK would be to increase public sector savings. With the present clamour for more spending on public services, this would mean increased taxes - over and above the increases automatically brought about by fiscal drag.

I should be happy to join fellow commentators in advocating a tax rise if I thought it would do any good. But the maximum that can be envisaged is the £7bn per annum increase advocated in the green budget of the Institute for Fiscal Studies - not on structural grounds but to reintroduce the degree of fiscal caution implicit in the 2001 Budget. Fiscal policy is not impotent. But an increase of that amount, probably staggered over several years and amounting to less than 1 per cent of GDP, would not be enough to shock the consumer into a more cautious mood.

The main eventual effect would probably be to finance yet more government spending - which is why impeccably sound-money US economists have jibbed against taking this route. Meanwhile, I would cite a wisecrack common in the Habsburg empire of a century ago: "The situation is desperate but not serious."

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