As Labour MPs demanded Mr George's sacking, Tony Blair clashed with William Hague during furious Commons exchanges. The Tory leader accused the Government of making the economic downturn worse during "a summer of complacency".
In the first session for three months of Prime Minister's Question Time, Mr Blair insisted he would honour pledges to boost spending on health and education by pounds 40bn despite the downturn, and claimed that the Tories would cut the two public services.
He attacked Mr Hague for his "idiotic hysteria".
But Mr Blair's counter-attack was overshadowed by the prospect of deep cuts at the Rover car company and a forecast by the European Commission that Britain will enjoy the slowest economic growth of any European Union country next year.
Mr Blair was forced on to the back foot by Mr George's comments, which echoed the former Chancellor Norman Lamont's 1991 gaffe that unemployment was a "price well worth paying".
Asked at a regional journalists' lunch whether he was saying that unemployment in the North was an acceptable price to pay for curbing inflation in the South, Mr George replied: "I suppose in a sense I am. It's not desirable, but the fact is that we can only seek to affect through monetary policy the state of demand in the economy as a whole."
As a storm broke at Westminster, the Governor insisted that his comments had been taken out of context and issued a statement expressing "disappointment" at the "misinterpretation". But ministers were privately furious, as Mr George's suggestion reignited fears that the Government is prepared to see dole queues lengthen to hit its 2.5 per cent inflation target.
Bill Midgeley, of the North East Chamber of Commerce, said: "I don't think the content is particularly surprising to many of us ... But to come out and say it is quite amazing and it doesn't do our economy in this part of the world any good at all."
David Clark, a former cabinet minister and MP for South Shields, said Mr George's remarks were "grossly offensive" and had caused "anger and offence" in the North-east.
When Mr Hague sought to exploit the storm in the Commons, Mr Blair insisted that allowing the jobless figures to rise to curb inflation was not the Government's policy.
Rejecting Tory claims that the global economic crisis would blow a pounds 36bn hole in the Government's plans, Mr Blair declared: "The great black hole is in the space where the Conservative party's brain used to be."
But Mr Hague accused Mr Blair of "extraordinary complacency". Today the Tories will launch a campaign comparing Mr Blair's response to the problems to the "crisis, what crisis?" statement attributed to James Callaghan, the then Labour prime minister, during the economic crisis of 1978.
Mr Blair urged Labour MPs at their weekly meeting yesterday to "keep your nerve" over the economy, promising light at the end of the tunnel as the extra public spending came through in two or three years.
In a letter to Mr Hague last night, the Prime Minister said the Chancellor, Gordon Brown, would confirm in his draft Budget on 3 November that he will stick to his tough fiscal rules despite the "serious deterioration in the world economic outlook over the last few months".
However, Mr Brown is expected to announce an increase in public borrowing because of the downturn. A study by the House of Commons library, commissioned by the Liberal Democrats, suggested yesterday that the public-sector borrowing requirement may have to rise by pounds 22bn over the next five years.Reuse content