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In all the public debate about the desirability of an independent central bank and the linked question of European monetary union, the main theme that emerges is mistrust of politicians. It is claimed we need an independent bank and an independent anchor, the Deutschmark, because we cannot trust our leaders not to manipulate the currency in the name of short-term expediency. There are some things, the argument runs, that cannot be left to democracy.

This thesis is fundamental and radical. Its implication is that a market-driven democracy is ultimately unstable. It will be undermined by inflation. Wise bankers are, in contrast, our only bulwark - because they are independent. Democracy needs to be protected from itself.

There are plenty of critiques of government failure, and much ink has been spent trying to design the appropriate institutional architecture to limit the scope for corruption and to provide a framework for longer term policy-making. An alternative approach is to ask the question: "What is a central bank for?" and then to decide how it should be related to government. Charles Goodhart has probably spent more time thinking about this problem than most observers of the British financial system. He has been on the inside as chief economic adviser at the Bank of England, and is now at the London School of Economics. In his collection of papers, The Central Bank and the Financial System, the first essay, "Why do banks need a central bank?" written in 1987, deals with the challenge provided by free market economists. What, they ask, is special about money, that requires special market institutions? Is money not just another commodity - like oil or corn - and therefore will not the normal forces of supply and demand determine its price? And if so, then we do not need central banks. Goodhart's answer is that the kind of assets banks hold are different from normal commodities in one important respect: they require fixed value. This is something markets do not automatically provide. It is a public good that requires intervention to preserve.

A subsequent essay, "What do central banks do?", considers how central banks may effect that intervention. In the monetarist paradigm, if governments can control the money supply, if changes in the money supply determine inflation, and if the central job of government is to control inflation (but not employment and the level of demand), then the central bank should be used as the instrument of government to achieve its objectives in providing the public good.

That simple causal chain was what many Thatcherites believed in the 1980s, and its logic found a practical content in the medium-term financial strategy. However, given this particular mental furniture, it is somewhat surprising that an independent central bank was not at the top of Margaret Thatcher's priority list. And indeed, as a later convert Nigel Lawson made clear in his political memoir, The View from No 11, she was not adverse to manipulating interest-rate policy when it came to political expediency, especially when it bore upon her ultimately disastrous promotion of the property-owning democracy. The implication is that she never fully accepted the economic theory behind monetarism, preferring to preserve room for manoeuvres - a view she became more taken with when faced with the possibility of European monetary union.

The reality, as Goodhart points out, is that central banks continue to manipulate the only real instruments they have - the price and/or quantity of money - to try to achieve the inflation objectives given by government. But they can only advise, as Eddie George, governor of the Bank of England found to his cost this summer when he pressed the Chancellor to put up interest rates. Instructively for those carried away with independent central banks, most commentators believe the Chancellor, not the governor, got it right in holding rates down. But in the run-up to the election, the tables may be turned.

The tangency or lack of it between the underlying economic theory of money, and the practical reality of policy, is brought out vividly in the collection of papers from the Tercentenary Symposium of the Bank of England, brought together in a volume entitled The Future of Central Banking. The chapter on modern central banking by Stanley Fischer provides a masterly survey of the theoretical debates from the Phillips curve through to rules versus discretion and builds up the case for a charter giving central banks a clearly defined mandate, the duty to publish its targets and a mechanism for accountability of its performance, together with control over the main instruments. The last chapter then summarises the contributions to the symposium of leading banking practitioners, including Lord Richardson, Paul Volcker and Karl-Otto Pohl. These give an insight into how independence might be handled. Volcker, for example, tells us that the lasting qualities of central banking are the triumvirate of continuity, competence and integrity. He states that "the central bank is inherently and properly a conservative creature". These qualities are, in his view, "in short supply in governments today". It is a short step to the idea with its populist thesis - that central bankers are here to protect us from the dangers of democracy.

The relationship between banking and politics is therefore closer than the economists' debate suggests. Central banking is not a purely technical exercise. This is admirably displayed in the history of central banking - what bankers have actually done, as opposed to what monetarist and Keynesian economists might like them to have done. The collection of papers entitled The Bank of England: Money, Power and Influence 1694-1994, edited by Richard Roberts and David Kynaston, provides an excellent historical summary. For those who lack the patience to wade through Kynaston's authoritative two-volume history of the Bank of England, his chapter in this collection distils the main conclusions on the relationship between the bank and government. Reading the volume, one is struck by the extent to which the main political policies of government that bear on overall economic management - like the gold standard and the reaction to the Great Depression of the 1930s - cannot be seen as technical matters alone.

But to recognise the political component is not to dismiss the economics. Nor should it automatically lead to the conclusion that independence is a dangerous course. Rather, it is to realise that independence cannot be anything other than conditional. It is about the balance of power between different parts of the informal British constitution - the Treasury, the Bank of England and the intellectual establishment. In a democracy, all are bounded by the voters, though each should influence their choice. Behind all these institutions remains a deeper reality - the performance of the British economy. While a stable currency may be a very desirable objective, there is no evidence to suggest that it is sufficient to ensure economic success. In the 1930s prices fell, but it was hardly a decade of unparalleled economic success.

In addressing current issues of economic policy - like the independence of the Bank of England, and European monetary union - it should be borne in mind that for the past 50 years the currency has been devalued repeatedly to maintain our external trade balance. The Government took the same course in 1992 on Black Wednesday. The value of the pound ultimately reflects the economic performance of the economy. There is no evidence to suggest that, come monetary union, Britain will be able to survive without the devaluation option. Ultimately, that is why politicians are reluctant to give up to control - to the Bank of England or the Bundesbank. Kenneth Clarke, the Chancellor of the Exchequer, will not want an independent governor to spike the popularity of his election tax cuts by putting up interest rates.

Dieter Helm is a fellow in economics, New College, Oxford.