The smell of roses fades for Mr Clarke

The economy is behaving well. I nearly wrote 'extraordinarily well', but actually there is nothing extraordinary about the present phase of strong economic growth, declining unemployment and subdued inflation. This combination has been seen many times before, and always at the present stage of the economic cycle - in the first two or three years following the end of a recession.

This is the period in which there is enough slack in the economy to ensure that growth can be above normal without initially causing any problems with inflation. Furthermore, inflation lags behind economic activity by about two years, so it continues to reflect the effects of the recession for quite a while into the upswing phase.

Many observers find it counter- intuitive that periods of strong growth tend for a while to be accompanied by declining inflation, but that has always been the pattern. In the 1950s and 1960s, economic cycles lasted an average of only five years from start to finish, so the benign periods of falling inflation and rising growth lasted only a couple of years.

More recently, recessions have become more infrequent, but also very much deeper than they were in the post-war period. The fact that these recent recessions have created more idle resources than before means that the benign phase of the cycle can last longer, simply because it takes longer to climb out of a deep hole than a shallow one.

EASY INNINGS

On the surface, it would seem preferable to time a political career so that one's innings at the Exchequer coincides with the easy phase of the cycle. Lord Barber, Lord Lawson and Kenneth Clarke are the three recent chancellors who have managed this most precisely. Norman Lamont was unlucky enough to be dealt exactly the opposite hand, while Lords Howe and Healey survived through a bit of both.

Of course, the immediate political reputations of the chancellors concerned have followed exactly the ups and downs one would expect, but this does not necessarily follow in the longer term.

Like an England batsman whose rash stroke throws away an impregnable position against Australia - Brian Close, for example, at Old Trafford in 1961 - a chancellor who squanders a good inheritance is never forgiven. By contrast, chancellors such as Lord Howe, who take tough decisions during the difficult phase of the cycle, later re-emerge smelling of roses. (Incidentally, I still expect Norman Lamont to enjoy a similar rehabilitation, although I am apparently alone in the world on this issue).

Kenneth Clarke must know he is entering the danger zone. His inheritance was good and, with the exception of the mistaken base rate cut in early February, he has done nothing yet to squander it.

But there is a pattern to this, too. At around the present stage of the cycle, chancellors and their advisers tell themselves that the one thing they must do on no account is to repeat the mistakes of the past. They must not be fooled into mistaking a cyclical recovery for something more profound - a structural transformation in the supply performance of the economy. They must remain tough when others before have buckled.

This phase lasts for a while, but then doubts start to creep in. Not doubts about impending failure, but delusions about continuing success. Perhaps the British economy has been transformed after all, the Chancellor thinks. Not too surprising, he muses, given the excellence of his policies. A supply side miracle is upon us, proclaim economic commentators who a short while before said that no recovery of any sort could take place. Euphoria turns to hubris just as the malevolent stage of the cycle returns.

The first signs of the hubris stage are usually spotted on the back benches, and sure enough there were calls last week for the tax increases of 1993 to be reversed now that the budget deficit has started to improve. Fortunately, the Chancellor moved quickly to quash this absurd speculation about tax cuts. But in case there are any remaining doubts, it cannot be emphasised too strongly that the Lamont/Clarke fiscal tightening was the absolute mimimum required, and that it has only barely placed the UK government in the sustainable zone on its public debt.

Anyone who persists in calling for tax cuts when the budget deficit remains above 7 per cent of GDP should call in at the shrink on the way to work this morning.

The only hope of avoiding the mistakes of the past is consciously to lean towards making policy mistakes in the opposite direction. Two years ago, when the economy was just stabilising at the bottom of the recession, it was appropriate to bias policy in an expansionary direction because the consequences of holding policy too tight were much more damaging than the opposite.

Now the risk/reward ratio has changed. Although it may conceivably turn out that policy is a little too tight as the tax rises take effect, the recovery is sufficiently well entrenched to survive any such policy mistake fairly comfortably. And a policy mistake in the other direction could easily result in inflation pressure down the road which would be harder to reverse.

When the Treasury Forecasting Panel met in February, we argued that the tax increases in April would not seriously dent the recovery, which was switching from consumer-led to company-led.

EITHER WAY FOR RATES

The conclusion was: 'We are now closer to the point at which we might recommend an increase in interest rates. Our presumption, therefore, is no longer that the next change in interest rates is bound to be downwards: it could be either up or down.'

This switch from an expansionary policy bias to neutrality was greeted with a certain amount of derision from some commentators, who still persist even now in extracting every ounce of bad news from economic figures that are basically upbeat. But it was the right judgement, and I am pleased to note from the minutes of Treasury/Bank of England meetings that it was a judgement simultaneously reached by Eddie George.

My impression is that the prevailing view in the Treasury, on the other hand, is that the Panel went a bit too far in specifically mentioning the possibility of base rate rises. This had an impact in the financial markets which was not welcome. But the real test of whether the new regime is serious about monetary stability is whether the authorities will be willing to raise base rates or tighten fiscal policy when they do not have to - in other words when there is no sterling crisis, and no immediate sign of rising inflation.

Action will need to be taken, and defended to the public, when there is no obvious trouble brewing, other than a decline in the estimated gap between actual and potential output.

This is the only way that inflation will be held permanently at the low end of the government's 1-4 per cent target range, but such action will of course mean that some calculated risks will need to be taken with the economic upswing at an awkward time in the political cycle. If he remains Chancellor, Mr Clarke's long- term political reputation will turn on whether he is willing, towards the end of this year, to tighten economic policy out of a clear blue sky.