Hamish McRae: The next chancellor will have a hard act to follow and a hard audience to please

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The long goodbye is also a long hello. We think we know Gordon Brown: all reason says that there will be no significant change in economic policy when he becomes prime minister. If he doesn't, things really will become interesting, but let's leave that possibility aside for the moment.

The political pundits have a while to speculate on what Mr Brown will be like in his new job, while those of us who are more interested in economics need to ponder whether the "nothing much changes" view is the right one.

The next chancellor - Ed Balls, Alistair Darling, whoever - will follow the lines set down by Mr Brown in office. That is not to say the new chancellor will simply carry out the master's orders, but he or she will have to operate within the fiscal framework that has been laid down. It follows that the challenges that have become evident during Mr Brown's period of office will have to be tackled in pretty much the same way by his successor.

We all know what those are. The Chancellor has managed to preserve a remarkably stable growth path by running a tight fiscal policy in his early years when global growth was strong and then running a loose one in the early 2000s when it was weak. That was fine. But he has maintained the loose fiscal policy, with large increases in public spending, during this second growth phase, repeatedly missing his fiscal targets.

You can catch a feeling for this big picture in the charts, both taken from the last Budget report. Mr Brown has pushed the tax-to-GDP ratio back up to the level of the early 1980s, which the Tories eventually managed to squeeze down. The overall spending level also increased steadily after his first two years, though it remains lower than in the 1970s and early 1980s. But while tax increases have a little further to run, the rise in spending is now more or less capped.

Meanwhile, the official figure for the fiscal deficit is a bit over 3 per cent of GDP, close to the practical limit. So the curb on the growth of public spending has to begin and tax may well have to rise further. Insofar as there is to be a change of policy, it is one already set by Mr Brown. It will be less agreeable for all of us and, since the next chancellor may only have a couple of years in office, none too agreeable for the incumbent either. If I were Ed Balls, I don't think I would want the job.

So that is the sensible assessment: no unexpected change in policy and no obvious looming disaster, but a somewhat tighter, more difficult time for all.

But things do not always turn out as expected and there seem to me to be at least three potential surprises.

The first stems from the internal dynamics of a Brown government, which will be different from those under Tony Blair. You could say that Mr Brown, as prime minister, will have no one to restrain him and that he will want to continue to run economic policy. But as prime minister he won't be able to micro-manage the economy in the way he has attempted to do up until now. It simply cannot be done: he is not in the right department.

The next chancellor will, in any case, need to differentiate to some extent. If macro-economic policy is a given, micro-economic policy is not. There is a lot of pressure from business for less fiddling, and to intervene less would be an easy "win" for the next chancellor.

Second, that there will be two years of squeezing productivity out of the public sector will change the relationship between the Treasury and other departments. Instead of the Treasury telling the rest of Whitehall what to do and dishing out money for specific aims, it will be deman- ding more output for not much more money. And it will be doing so under a weaker chancellor. Expect the tensions in this rougher relationship to be evident. This is an area where there are no easy wins.

Third, the external environment will be different, though how different we can't know. There is still such a thing as a global economic cycle and it seems clear that the present expansionary phase is pretty mature.

That is not to say the next global recession is imminent. The world faces some sort of slowdown next year, led by the US consumer holding back a bit, but this does not yet feel like the end of the cycle. If past history repeats itself, however, we should expect a sharp slowdown by 2009, which would mean an eight-year expansion. The question then would be whether Britain was in good shape to pull through it.

The UK economy seems quite competitive in world terms but we would go into the next downturn without the cushion of a fiscal surplus, unlike last time. So it would be much harder to offset a fall in global demand by loosening fiscal policy.

The new chancellor, then, will have one advantage over the present one - no compulsive drive to fiddle - but the internal environment will certainly be more hostile, and the external one will probably be so too. So things will feel different.

All this presupposes that Mr Brown does indeed become prime minister. If not, what then?

Well, bear in mind that any large and growing economy has momentum behind it and, in our interdependent world, what happens to the big global numbers is more important than what happens to domestic politics.

Suppose a disruptive succession battle was followed by two years of weak government. Provided global growth continued and the new government did not do anything particularly stupid, the UK economy would carry on with decent growth. It has surprised in the past 18 months by its ability to employ another half-million or more workers from the new EU member states. It could surprise again.

On the other hand, were the core disciplines of Mr Brown abandoned, we could be in some difficulty. The UK needs to retain its place as the second-largest recipient of foreign direct investment and that requires continued international confidence in our economic management. We need the money in part to offset the current account deficit, but also to carry on bringing foreign talent and skills into the country. Those disciplines established by Mr Brown, for all their flaws, have helped the economy to continue with the growth he inherited. Whatever happens next, he deserves credit for that.

The pound is living high on the hog

The simple questions are hardest to answer. Last week I was asked by a delegation of visiting Japanese MPs: "Why is the pound so high?"

They must have been aghast at London prices, rather as we used to be aghast at Tokyo's. Sterling may not be that high against the euro but it certainly seems so against the dollar, and it is also high against the yen. Yet we have that quite high current account deficit and, at current exchange rates, London is the most expensive business location in the world. How do we justify that?

The answer comes in several stages, for there are at least five reasons why sterling should be strong, indeed somewhat over-strong, against most currencies.

First, the UK is still an attractive place for foreign investment. The Economist Intelligence Unit forecasts that we will be second only to the US as a recipient of foreign cash through to 2010.

Second, the world's central banks have been rebalancing their reserve assets away from the dollar, with the pound becoming the third-most popular currency. Whatever views we have about the rights and wrongs of keeping the pound, the world's central bankers are clearly glad we did so.

Third, the surge in the oil price has greatly increased the cash-flow of the Middle East, and London is where much of that money is managed. Some of those funds will find their way into sterling assets - maybe slightly more than would have happened had they been managed elsewhere.

Fourth, UK property markets, both commercial and residential, are transparent and have performed well. So the UK gets more than its share of foreign property investment.

And finally, with the UK not now very dependent on price-sensitive manufactured exports, the strong pound has not done as much damage to the current account as might be expected. Exports of most services seem less sensitive to a strong pound.

If all this is right, sterling could remain buoyant for quite some time. But if for any reason the UK becomes a less attractive place to invest, then the forces supporting the pound could go into reverse - and we will stop coming back from holiday bragging how cheap it was to get a good meal in Paris.