Britain enjoyed the best of all worlds only two years ago. Economic growth outstripped most of our competitors, energy prices were below the European average and emissions of carbon were falling while many others were struggling to prevent them from rising.

But this year the golden glow has turned to rust as economic growth has fallen below trend, energy prices have risen rapidly to among the highest in Europe and carbon emissions have started to rise again. Stories of potential power shortages this winter causing factory shutdowns that once seemed alarmist now have a ring of credibility.

How did we get here? Do our targets to reduce carbon emissions still make sense? And what should we do now? Over the last year, Britain has become far more dependent on imports of gas, exposing us to distortions in largely unliberalised energy markets on the continent that leave us paying more for their gas than they charge their own customers.

The government is pressing our European partners to liberalise energy markets but this may take decades. The next two years will also see the construction of pipeline and storage capacity, though we will have to endure two difficult winters before this is completed.

Rising gas prices have led to increasing use of coal to generate power. Coal generates far more carbon emissions than gas, causing the price of carbon in the EU emissions trading scheme to rocket from about €8 (£5.50) a tonne to highs of nearly €30. In Britain's more liberalised energy markets, power prices are much more sensitive to movements in the value of carbon emissions than in much of the rest of Europe. Our power prices have risen much faster, with businesses reporting price rises of between 50% and 80% this summer.

This is bad news for the government, which included targets that go well beyond the Kyoto protocol to reduce emissions in its election manifesto, despite mounting evidence that they were looking increasingly unrealistic. Unfortunately for the government, statisticians from the Office for National Statistics are unlikely to ride to their rescue by revising the data. The recent rise in coal use has exposed how much the government relied on the dash for gas to reduce our emissions and how little the rest of its strategy contributed. Britain has done little to tackle emissions from houses and vehicles while progress on the "renewables obligation" has been much slower than the government forecast, despite the National Audit Office's expectation that it will cost an annual £1bn by 2010. An EEF survey will show companies are paying growing attention to energy efficiency but the organisations charged with promoting this have yet to really connect with employers despite generous funding from the climate change levy and the landfill tax.

We are concerned that the government will look for a crash diet that will bring its weight-loss programme back on track but with probable severe side-effects. It might heed some of the more extreme calls to double the rate of the climate change levy. Far more sensible would be to set a realistic timeframe for achieving its targets and to outline a balanced programme that will enable it to get there. This must include a greater focus on reducing emissions from homes and transport.

It should also examine how it can engage with business more effectively over energy efficiency. We suggest it channels more of its efforts through the Manufacturing Advisory Service, which has a track record of delivering credible advice to business. Measures to encourage investment in new equipment and research and development to promote lower energy use and emission levels should be made more accessible.

It should review the role played by the climate change levy. Longer-term, there must be questions as to whether emissions trading makes the levy redundant. In the meantime, it should take heed of evidence that climate change agreements that set business targets to either improve energy efficiency or reduce emissions in return for a discount on the levy have proved far more effective in reducing emissions than the levy itself.

The time may be right to exempt nuclear energy from the levy since it emits no carbon. It is also time to develop a long-term energy strategy that looks seriously at what will deliver reductions in carbon emissions for the least cost, while also delivering a secure and reliable supply of energy. Tough decisions lie ahead but addressing climate change was never going to be easy.

· Steve Radley is chief economist of EEF, the manufacturers' organisation