The Big Question: What's gone wrong between the Chancellor and the Governor?

(Reuters)

Why are we asking this now?

Because of the unprecedented public discord between the Bank of England and the Treasury, breaking the usual conventions and giving the impression that financial regulation in the UK is a mess and the governor lacks confidence in the Government. The Bank and the Financial Services Authority have also clashed, though all sides deny they are engaged in a "turf war", and seek only faith, hope – and clarity. The intervention of the Conservatives "on the side of the Bank" also threatens to jeopardise the Bank's cherished image as a stoutly independent organisation free from political interference.

The caricature is of a wrestling tag fight, with the Labour government and the Financial Services Authority in the red corner, in the form of Alistair Darling and FSA Chair Lord Turner, limbering up in their leotards. In the blue corner we find the Bank of England and the Opposition, made flesh by Mervyn King and George Osborne. Liberal Democrat Treasury spokesman Vincent Cable might be cast as the referee.

There are dark rumours about Mr King giving an advance briefing to the Conservatives on the banking recapitalisation last year, information that they then used to ambush the Chancellor in the media. However, behind the crude image of politicians and bureaucrats wrestling in the mud for position – and lobby gossip about the personalities – lie some crucial disagreements about issues of huge importance.

Did Mr Darling deliberately snub Mr King?

Not exactly. Despite the Bank's injured pride, some believe that the failure of the Treasury to show its White Paper to the Bank before now comes into the "cock-up" rather than the conspiracy category and was purely the result of pressure of deadlines. However, Mr King was very precise in saying that, "I have not been consulted on what will be in the White Paper". It is difficult to believe that two men who gave such radically different views to the same event – last week's Mansion House dinner – are exactly able to read each other's minds.

What are they arguing about?

To some ears Mervyn King sounds like a repetitive version of Winston Churchill – "Give us the tools and we will finish the job". Mr King's biggest moan is that the Government lumbered the Bank with a statutory duty in this year's Banking Act to "contribute to protecting and enhancing the stability of the financial systems of the United Kingdom" – but has stubbornly refused to give it the powers necessary to finish the job.

In the jargon, Mr King wants to possess a "macroprudential toolkit" to discharge his legal obligations. That means the power to order banks to lend more or less by, say, varying the amount of cash they have to hold in reserve (and are thus unable to lend out or, in the view of some, gamble).

What is the Bank proposing it should do?

The Bank has suggested a series of technical measures that could achieve its overall aim of "protecting the economy from the banks" – preventing them from becoming too big and from taking on too much risk, especially where a mishap could cause much wider damage to the financial system and the wider economy ("systemic risk").

The Bank also wants to be able to control the amount of credit sloshing around in the economy, hopefully restraining the share and property bubbles. It also thinks that if a bank is "too big to fail", then it is just too big. But the Government shows no inclination to give the Bank its toolkit, which it fears will merely confuse the banks.

Some observers believe that to do so, on top of the Bank's existing power to set interest rates, would mean handing over the running of the economy to Mr King, a clever but unelected official. The Treasury also seems to think that it is unrealistic to try to break global banks up.

But for his part Mr King thinks ministers are taking "an awfully long time" to get their finances under control. Though conceding that the Chancellor has been "commendably honest" in his Budget, he also called on Mr Darling to show "slightly more ambition". Earlier this year Mr King effectively vetoed a government plan to introduce a further fiscal boost. He has called on Mr Darling to produce a "credible" plan to reduce the deficit. Mr Darling shows every sign that he would love to do so, but, with an election less than a year away, the toughest choices will be deferred.

Is the Governor entirely gloomy?

No.10 is reported to be unhappy about the miserable mood music that emanates from the bank's economists. However, Mr King said yesterday that he thought the depreciation of the pound, a run-down in stock levels and the massive cash injection he has put into the economy – £96bn so far – will support "some sort of recovery".

Is this sort of row really unprecedented?

Yes, in public anyway. Private rows between prime ministers and governors of the Bank of England, with chancellors on various sides, have been far from uncommon.

One of Mr King's predecessors, Robin Leigh-Pemberton, had the unpleasant task of telling Mrs Thatcher that he doubted the wisdom of her monetarist experiment t in the early 1980s. In the post-war era, relations hit a low point in the 1960s when the then Governor, Lord Cromer, told Harold Wilson that his Labour government's polices were impractical. Wilson, in return, threatened to call a general election unless the Governor did as he was told. Cromer relented, and before long was replaced by the more emollient Leslie O'Brien. Wilson was convinced Cromer was a Tory sympathiser, a view he took to be confirmed when his Conservative replacement, Edward Heath, with whom Cromer was friendly, appointed the ex-Governor to the plum job of ambassador to Washington.

Despite assurances, few believe that Mr Darling and Mr King get along as well as the affable pairing of Governor Eddie George and Chancellor Ken Clarke in the 1990s, where their publicly minuted exchanges were dubbed "the Ken and Eddie Show". Then again it is apparent that Mr Darling gets on better with the Governor better than Gordon Brown did as Chancellor.

What happens next?

The Government will publish its ideas next week, and the Conservatives' proposals will follow. Then there will be a lull as the other bodies concerned – everyone from the EU to the multinational Financial Stability Forum and the International Monetary Fund – grind their way through the detail.

Despite the apparent urgency of Mr King and Lord Turner's pleas for clarity and a better alignment of "powers and responsibilities" for the two regulators, Mr King himself admits that the authorities can take their time in framing the new instruments that will be needed to rein in the banks (should these ever get the go ahead). They will be, in any case, exceedingly complex. All the parties agree on one thing - this s issue is unlikely to be settled before the election. There e is plenty of time for more, ahem, "debate".

Can the two men come to an agreement?

Yes...

* Both the Chancellor and the Governor agree in principle that the Government needs to get public borrowing down

* Both also agree that the City of London and the financial services industry needs to be more closely monitored

* The tough decisions on spending cuts will be deferred

No...

* The Governor will not be happy until the Banks of England's powers are clarified

* The level of discord between the two parties is unsustainable – something, or someone, will have to give

* The battle has already become too too bitter and too political for a workable settlement to be reached