What comes after the Ken and Eddie Show?

The meetings of the Chancellor and the Governor of the Bank of England may be replaced by something less agreeable

Although the Chancellor of the Exchequer and the Governor of the Bank of England have been starring in what the City and Whitehall call "The Ken and Eddie Show" since the middle of 1993, experience didn't save them. Last week they both lost the plot.

When Kenneth Clarke revealed on Wednesday morning that he was ignoring Eddie George's advice to raise interest rates for the third month in a row, he caused particular offence among grandees at the Bank by chosing to do so on the Today programme on Radio 4. He was showing contempt for the usual, discreet channels.

As for Mr George, he has been talking about a completely different act with Gordon Brown, the shadow Chancellor, the man most likely to be the next star. Each side is faintly embarrassed that this news has leaked, and blames the other, but the fact is that Mr Brown and Mr George have agreed within the past two or three weeks on reforms to the present system of fixing interest rates, to be introduced if Labour wins office.

The cause of last week's squabble between Mr Clarke and Mr George is the price of money, or the rate of interest. The Governor and his advisers believe that it should rise from its present level of 6 per cent to 6 1/4 per cent so as to prevent inflation from rising above 3 per cent in two years' time. Since the Chancellor's survival until 1999 is doubtful, plainly Mr Clarke wants to be sure that the price of money does not inhibit the steady growth in the British economy now - especially within weeks of a general election.

This is a serious debate about expectations for employment, inflation, the value of sterling, and ultimately about the independence of the Bank of England. And one of its most surprising features is that we should know so much about the argument.

The relationship between the Treasury and the Bank is uneasy. In the Bank, the Treasury is known euphemistically as "the other end of town" as if to suggest a partnership of equals, but the Act nationalising the Bank in 1946 gives the Treasury the right to tell the Bank what to do (after consultation, of course).

But the balance of power is more subtle than that. A powerful governor, such as Gordon Richardson in the 1970s, can mesmerise the Treasury. A weak one - Robin Leigh-Pemberton in the 1980s - is an irresistible target for bullying politicians, such as Nigel Lawson.

The crucial moment in recent history was Black Wednesday - 16 September 1991 - when Norman Lamont, then Chancellor, ordered the Bank to support sterling in an effort to keep it inside the European ERM (Exchange-Rate Mechanism). When the exercise failed, and sterling fell by some 20 per cent, the losses climbed close to pounds 4bn. The Treasury suffered a rare loss of confidence, and the Bank was asked to help pick up the pieces.

From the debacle arose a commitment to set a strict target for the inflation rate, and to give the Bank a formal role in meeting it. The Bank was instructed to produce an Inflation Report every three months assessing the Government's success in meeting the target, and the Treasury promised to publish a report after the regular monthly meeting with the Chancellor.

After Mr Clarke became Chancellor he voluntarily shifted the balance of power in the Bank's favour by ordering that the minutes of his monthly conversation with the Governor should be published - only six weeks later. This means that there are no real secrets on interest-rate policy. The Chancellor is under the public scrutiny of his critics, inside and outside the Bank. It was, said Mr George, "a terrific decision". It was also the start of The Ken and Eddie Show.

They are well matched. Of similar age (Mr George is 58, Mr Clarke 56), both are meritocrats, educated at Cambridge. Both smoke and without apology. Each is fiercely ambitious, has a fine opinion of himself, and likes his own way.

Sharp disagreements have punctuated their relationship in the past three years. The first of them provided an absorbing opening act when, in the spring of 1995, Mr George declared that there would be a sterling crisis if the interest rate was not raised from 6 3/4 to 7 1/4 per cent. He said so three months in a row.

Mr Clarke believed that raising rates would endanger economic recovery, stubbornly refused, and, months later, the Bank decided that its formula for calculating the likely rise in inflation had come up with the wrong result. One-up for the Chancellor

But the problem that perturbs Gordon Brown had already become clear. Defined by Philip Stephens in his book Politics and the Pound, it is: "If the Chancellor refuses too often the advice of the Governor, he risks undercutting the credibility of the anti-inflation strategy. If he accepts the Bank's word against his own best judgement then he invites a political backlash at Westminster."

The Governor was proved right when the two disagreed last summer, while it is too soon to declare the outcome of the latest squall. Mr Clarke is performing without the assistance of many of his own advisers in the Treasury, many of whom apparently share the Bank's view that a small rate increase is desirable.

The case for this was made in its latest Inflation Report, published last Wednesday, which concluded that inflation will fall in the next few months and that it will then rise to around 3 per cent - half a point above the 1999 target.

Matters are complicated by a technical debate about the recent sharp rise in the value of sterling, and it is hard to judge which side is right this time, although there is no doubt that Mr Clarke's determination to emphasise jobs rather than inflation is more likely to appeal to voters, which is the main reason why Labour insists the process has lost credibility. By the time Mr Clarke is shown to be right or wrong, Mr Brown is likely to be sitting in his chair, and changes will make the system less gladiatorial. If there were a Show under Mr Brown, he would seek to deny a prominent part for Mr George.

Labour has had an instinctive mistrust of central bankers ever since the Great Depression, and an autocratic governor of the Bank is one of the few figures who can arouse old-fashioned prejudice even in New Labour. Mr George, an autocrat by inclination, has been cleaning up his act recently, sharing power with his able and articulate deputy, Howard Davies, and his chief economist, Mervyn King. But this will not satisfy Mr Brown, who has already outlined his plan for a new monetary policy committee with the all-powerful governor reduced to the role of chairman, and the Bank's authority diluted by committee members drawn from outside.

Mr George has no objection to this in principle, and has told Mr Brown so, but Labour sources say that the Governor's future depends on the enthusiasm with which he adapts to a new style of decision-making. His term is up in the middle of 1998, and if he does not please his new masters a successor could be named as early as the end of the year.

Mr George's greatest ambition is that the Bank should fix interest rates independently of the Treasury, a freedom taken for granted at the Federal Reserve in Washington and the Bundesbank in Frankfurt, and the oddest political feature of this debate is that, assuming the new monetary policy committee inspires confidence, New Labour seems more willing to contemplate an independent Bank than the Tories.

There is a qualification to this, of course. Should Labour decide to join EMU - the single currency - interest rates would be fixed in Frankfurt not Threadneedle Street, and we would be robbed for ever of follow-up series to The Ken and Eddie Show. Pity, in a way. It deserved its reviews, which said it was "entertaining and educational".