War. Terrorism. Recession. Now Blair really does face hard choices

We are all doomed. That is more or less how Tony Blair's New Year message was interpreted. The full text is not quite so gloomy as the reports suggested, but even so it does not contain many laughs. The world economy is tottering. There will probably be a war against Iraq. We risk being blown up by terrorists. Apart from that everything is fine.

The message was widely seen as a significant departure from Mr Blair's usual style, but this is not entirely the case. In 1997 when the economy was soaring, the media were doting and the Government's standing in the polls was stratospheric, Mr Blair spoke grimly of "hard choices". Two years later when all those rosy conditions were still in place he insisted there could be no turning back from the tough course the Government had fearlessly embarked upon, as if the country were in the midst of a revolution that would prove worthwhile in the end. At another equally sunny moment, Mr Blair reflected that the Government was in its "post- euphoria, pre-delivery phase". Admittedly, these downbeat messages were occasionally interspersed with heady oratory that implied that a prime ministerial visit to a council estate had in itself revolutionised the welfare state. Even so, Mr Blair's New Year's tidings were not quite as unusual as they seemed. In the good times he had a tendency to prepare for the worst.

Still, his evocation of a traumatic 2003 dominated the headlines in a quiet news week. So much so that there may have been a connection between Mr Blair's downbeat communication and the uncharacteristically rousing appearance of the Governor of the Bank of England, Sir Edward George, on Friday's Today programme. Sir Edward has in some ways been an austere governor with hawkish tendencies when it comes to setting interest rates. There was no sign of this last week. Go out and enjoy yourselves was his broad message: forget about talk of war, the risk of being blown up, and that the economy's up the spout. The tone of Sir Edward's message could not have been more different to how Mr Blair's had been reported.

Perhaps Gordon Brown had been alarmed at the way Mr Blair's words were received, feared that no one would go shopping or buy a house for the next 12 months, realised that he could not give an interview without provoking reports of another Blair/Brown split, and so had a quiet word with Sir Edward. Whatever the reason, Sir Edward evidently wanted to convey the message that there was no need for panic.

The stakes for the Government could not be any higher. The economy more or less determines the fate of most administrations, although there are exceptions to this rule. John Major won in 1992 in the middle of a deep recession, and lost in 1997 when the economy was performing reasonably well. Margaret Thatcher won a landslide in 1983 when parts of the country were in recession. The difference is that New Labour has made economic competence an overwhelming objective, almost an end itself. From the beginning it proclaimed it would be different from previous Labour governments and the helter-skelter of the Tory years. It would bring an end to boom and bust. If bust were to make a reappearance on the political stage New Labour would have to exit left, or possibly exit right.

Apart from anything else the political language invented by Mr Blair and Mr Brown gives them little room for manoeuvre. The Chancellor's attachment to prudence has already been mocked, now that he has been forced to borrow billions more than he had anticipated. What would happen to the attachment if he was forced to borrow considerably more? Prudence would have to get up and leave for good.

Yet, having made clear their disdain for higher taxes beyond the increase to be implemented in April, the Prime Minister and the Chancellor cannot easily put them up again. Whether they should or not is another matter. Their political positioning makes it almost impossible. After all, it was not so long ago that Mr Blair – in an interview with The Independent in September 1999 – was hailing an era of much lower taxation.

The other option of cutting public spending is also politically impossible and entirely undesirable. The lack of investment in Britain's creaking infrastructure is being addressed for the first time in 30 years. The additional cash is starting to make a difference, in some cases a significant difference, but it is the minimum required to reach the standards enjoyed in most other European countries. If anything, the level of spending in some areas – especially transport – might not be enough.

Not all these optionsnecessarily come into play, especially if Sir Edward's more upbeat message is heeded. Some of the economic indicators are far from gloomy, with inflation low and employment high. The situation regarding the housing market is bizarre. When prices were soaring out of control it was a disaster. Now they are not soaring out of control it is also a disaster. In my view the former situation was incomparably more disastrous. Around London and the South-east, and several other cities, house prices have become unsustainable, making it hard for public services to attract new recruits.

High house prices have also been a factor in the Treasury's caution over the euro. Lower interest rates are almost certainly a precondition for convergence with the other economies in the euro zone. When house prices are rising crazily it is hardly desirable to have lower interest rates, making mortgages more affordable. Now it might be necessary to lower interest rates in order to give the housing market and consumer demand a gentle boost. Here is a possible scenario for this year: interest rates are lower, Britain joins the euro and manufacturing industry revives. I think I must take a lie down in a darkened room with the excitement of it all.

Although such an intoxicating sequence is unlikely (though by no means impossible) there is equally no cause for an excess of gloom. The economy is at one of those hairy junctions when a rash of negative predictions becomes self-fulfilling. If a series of housing experts predicts a big fall in prices, and their predictions make the front pages, the fall becomes more likely. Similarly, consumers become more gloomy when they read about how gloomy they are.

Which is why in the near future Mr Blair will probably emphasise the section at the end of his New Year's message that was buried beneath the doom – that Britain was well placed to meet the economic downturn. When a Prime Minister faces genuinely hard choices, it is sometimes wiser to play them down.