Leading Article: Clarke's euro-credentials are yet to be tested

Ken Clarke's behaviour is startling. We have such low expectations of politicians these days that, when a Chancellor stakes his power and position on a principle (in this case, keeping the door to European Monetary Union open), we sit up with renewed regard. His bullish behaviour on Europe is doing wonders for his economic credibility too. After all, if the man will not sacrifice his faith in Europe for short-term political gain, presumably he will decline to rock the economy in pursuit of votes, as several of his predecessors did.

But we should interpret Mr Clarke's decisions with care. On both Europe and the economy, the Chancellor is pursuing deliberate and calculated high-risk strategies. His attempt to bounce his party away from destructive Euro-scepticism is admirable. However, he is taking too many chances with the domestic economic outlook. A responsible chancellor, or central bank governor, would put interest rates up now. In fact the Governor of the Bank of England, Eddie George, yesterday advised the Chancellor to do exactly that. Mr Clarke has so far refused.

In the short term he is bound to get away with it. But he is creating the conditions for a boom which we may all regret several years down the line. Admittedly the Chancellor's decision to overrule the Governor last summer by refusing to raise interest rates proved correct. Thanks to recession in Europe, and firms running down their stocks rather than producing new goods, growth slowed. Had interest rates gone up, we might have suffered a more substantial slowdown.

But it would be foolish to reason by induction. Just because the Chancellor was right once does not mean he is right now. With export markets now expanding, and firms having completed stock adjustments, the need to insure ourselves against a slowdown has eased. More importantly, it looks as though consumer demand is rising disturbingly fast. Retail sales are rising at the fastest rate since 1988. Consumer confidence is up, and so is borrowing. Right now, we are a nation of shoppers.

However, if the economy cannot grow fast enough to keep up, we will find ourselves in the midst of an inflationary boom all over again. Given that investment has remained so sluggish during the recovery, it would be surprising if British business could expand fast enough to match rapid increases in demand. Our previous boom-and-bust record suggests that the British economy is incapable of sustaining high growth without inflation taking off.

Mr Clarke, however, remains optimistic. He cheerily maintains that the economy can pick up speed without inflation rising, and he is choosing his interest rates accordingly. It is always possible that he could prove right, if the behaviour of the British economy has fundamentally changed in the last five years. If we remain sceptical, it is not least because we have seen economic miracles turn out to be mirages before.

The worst of it is that the Chancellor will be able to get away with his optimism until it is too late. Changes in the economy can be slow to feed through to our perceptions. Time and time again, we find ourselves in the middle of a boom or tumbling into a recession before we know it. This time, voters are understandably reluctant to believe the good times have arrived. Although the economy has been growing steadily for several years, and consumer spending is accelerating apace, the feelgood factor is still fragile. Inflation is still low, house prices are not yet escalating, and unemployment has not yet fallen to its Eighties nadir.

So when Kenneth Clarke tells us there is plenty of room to manoeuvre, and no need for rate increases to slow the economic expansion, he sounds eminently plausible. The only trouble is that by the time everyone agrees he is wrong it will be too late to do anything about it. Interest rates take two years to have their full impact on the economy. Given that the evidence suggests that inflation will be rising in two years' time, a small rise in interest rates soon, while the boom remains a twinkle in a shopper's eye, could prevent the need for drastic medicine later on.

Sooner or later, should he stay in the job, Mr Clarke is bound to bow to the Bank's advice and put rates up. Faced with overwhelming evidence of inflationary pressures, he should play the good Chancellor and raise the cost of borrowing regardless of the effect on votes. His position is too important to risk his entire reputation as well as the economy on the slim chance of a Conservative victory. The trouble is that political pressures will encourage him to delay as long as possible. The Conservatives will be relying on as large a feelgood dollop as Mr Clarke can ladle up. But with tax cuts no longer a vote-winner, thanks to the dismal state of the public finances and popular cynicism about Norman Lamont's 1992 capers, low interest rates may be the only way of allowing people to feel well off, however temporarily.

Curiously enough, Mr Clarke's economic strategy over the next six months may prove the test of his European principles too. The prospect of a possible inflationary boom in two years may not be appalling enough to make him push up the cost of borrowing. But is he prepared to risk Britain failing the Maastricht criteria and ruling itself out of his precious single currency?

If we do not increase interest rates for the next six months, we could even jeopardise our chances of meeting the Maastricht criterion on inflation by 1999. So if Kenneth Clarke keeps rates too low, we will suspect that his commitment to monetary union is as tempered by political pragmatism as his interest in sustaining economic growth. The next six months will prove whether Ken Clarke is really a good European, as well as a good Chancellor, rather than just a clever politician.