Leading Article: On inflation, the Chancellor must dress to kill

This is the story of the Chancellor's New Clothes. Gordon Brown paraded his lounge suit at the Mansion House yesterday and delivered his Big Speech. "Look, he's not wearing a penguin suit!" shouted the little boy. In this version of the story it was the little boy's older brother, who works in the City, who added dismissively: "He's got no clothes on at all." From Flash Gordon to Flasher Gordon in one short month.

The older brother and his City friends are not impressed by the new inflation target. To them it looks suspiciously like going naked into the fight against inflation. They are too worldly-wise to be taken in by the Chancellor's courtiers, who prepare the way for his triumphant progress through the crowds by leaking details of his new clothing to the Financial Times. According to yesterday's FT, the Chancellor's new lounge suit is made of stiffest anti-inflationary fibre and reinforced prudently with golden- rule thread. Well spun.

However, as we report today, Mr Brown has replaced a target range for inflation of 0 to 2.5 per cent with one of 1.5 to 3.5 per cent, despite his categorical declaration that "the thresholds do not define a target range". That does indeed look like a relaxation, and there are many who will be tempted to say that would be a good thing: it is always tempting to think that a little bit of inflation is a small price to pay for economic growth and getting people into work. But the new inflation target does not mean that policy will be relaxed, and nor should it be. On the contrary, now is the time to be most unsentimental in cracking down on inflation.

The courtiers of the Chancellery are actually quite right when they claim that the new target will be tougher in practice than the old one because it will be pursued by an independent Bank of England, rather than by politicians. They also have a case when they point to the Conservative record of casually missing the target. And it is time to be tough. It is not just our globally- warmed summer climate, our new, clean and fresh government, our coincidental sporting victories: there really is a feel-good factor out there. That much was obvious long before the election. The economy has been booming for some time. The numbers show that we are in the middle of a strong economic upswing. We are at a high point, and that is always the dangerous point in the cycle, because it takes about two years for policy mistakes to show up in the inflation figures, and it is all too easy for policy- makers to believe optimistic forecasts. Inflation, once a blip no bigger than a man's fist, nearly ran out of control in the Lawson boom in the late Eighties for that reason. It has been low by British standards since then, but still higher than in most of our competitor countries. And the risk of another upward blip is real. The potential for wage inflation is there, with falling unemployment and reports of skill shortages. Add to that the huge flow of cash into the economy from the "privatisation" of building societies, bringing more upward pressure on prices. Up to half of the windfalls are being saved, but a lot is being spent on foreign holidays and home improvements.

The real danger, however, comes from the Prime Minister's pounds 200,000 windfall profit on the impending sale of his Islington house. The housing market is the engine of inflationary booms and one of the strongest temptations of the "a little bit of inflation never did anyone any harm" school of thought. It is vital to break the inflationary psychology of house prices, and Mr Brown should act in next month's Budget to phase out the remaining tax subsidy for mortgages. All in all, then, there is a lot to worry about on the inflation front.

If Mr Brown pays attention to those risks, and tackles things like the house price inflation problem, then all the elements will be in place for a credible and tough stance on inflation which could lay the foundations of the much-vaunted "stability" which Mr Blair and Mr Brown claim to seek. They have acted astutely to take the critical decisions without delay, which will make it easier to stick to the strategy when the ride gets rougher, as it undoubtedly will. One cleverness in Mr Brown's speech last night was the way he built into the inflation target a correction mechanism in case the Bank of England adopted too tight a policy in a downturn. Already, neo-Keynesians are complaining that Labour's plans to move 250,000 people off the dole and into work are doomed to failure unless demand is stimulated so that there are real jobs for them to go into. This misses the point, which is that unemployment is falling so fast that the Government is running out of 18- to 25-year-olds to put on its schemes before they have even been set up. But there will come a time - probably around the time of the next election - when economic forces will turn round, and Mr Brown will come under political pressure to change the terms of the Bank's remit. It will help a little, electorally, that the Bank is now at arm's length, but Labour needs to make the case for low inflation. In the short term, there is a trade-off between jobs and inflation, and it is tempting to prefer jobs. But inflation has a momentum and a psychology of its own, and in the end destroys jobs.

In a few years' time, Mr Brown will have to cast aside the new-look lounge suit and don the armour of the Iron Chancellor, protected against the inevitable half-bricks that will be hurled in his direction, many from his own party or its natural supporters. For that, he will need to be explicit about why inflation is a Bad Thing, and why in the long term low inflation is essential to creating jobs. In government, as in marriage, it is best to start just as you mean to go on.