Question: The Chancellor is due to make his pre-budget report - and he's indicated he's going to rule out tax rises, he's assured everyone that the government's spending plans remain intact and he's promised business he intends to spread an enterprise culture. He seems to have covered all the bases?

Ken Clarke: I don't think he'll deliver a pre-budget report that resembles that very closely. He has never in the past trailed anything that he's going to say and I think he likes to surprise and he likes to have gimmicks and he will probably produce some unexpected new tax breaks for business.

I hope he isn't as complacent as your question makes him sound because for the first time in his career as Chancellor of the Exchequer he faces a very difficult problem in planning over the next two or three years. He can't afford the fiscal plans he's already made, but he's being pressed by the Prime Minister to keep increasing the rate of public spending as quickly as it has been rising in the past couple of years. At sometime he has got to get round to tax increases, but he's also got to take a considered view on how he's going to keep the British economy on track.

Question: Not for a few years yet though?

Ken Clarke: The Labour government always likes to do the difficult things in the first two years of the government and hand out the goodies, at least by way of promises, in the second half. He won't want, I don't think, to save up the bad news for the eve of the next election. I'm not sure that he has ruled out tax increases. At their Party Conference he and his Prime Minister rather hinted, that tax increases would need to be contemplated. Sooner or later, for example, they are going to take the ceiling off National Insurance contributions for higher earners. Poor Mr Blair will get pale at the problems that this will cause for his target middle-England middle-income voters but I think Brown intends to do it and he will probably trail it in the course of his announcement this week.

Question: So you are expecting him to trail tax rises?

Ken Clarke: He may agree with my analysis that at some stage he's got to raise taxes. In my own opinion it's when not whether. From that I rather think that he's likely to trail tax increases now and probably do what he's done in the past which is announce tax increases now which won't take effect for another year or two. I can't think that he'll just give sunny good news in the forthcoming budget and save up any possible bad news for later in the Parliament.

Of course he does have the perfect excuse after the World Trade Centre disaster because every finance minister in the world who is facing some rocky decisions is blaming it on the September 11 terrorist outrage, just as every Chief Executive of a rocky corporation that was getting into trouble is blaming the cut backs that they are now making on the World Trade Centre outrage. So I just think Gordon is not going to be either so complacent or so cheerily optimistic as you're imagining.

Question: What else do you think the Chancellor should be saying in this pre-budget report?

Ken Clarke: I think he should be saying that the British economy has been going through a very serious slowdown and that is likely to continue for some time. I don't think we're necessarily going into recession but we're probably going to repeat the 1998 experience. It's getting very near to that at the moment. The main thing that's buoying up the growth of economy is consumer demand which is going to slow up as unemployment rises and people realise that the economic outlook is more clouded. Then there is the high level of public expenditure which is working its way through to public sector pay. That is working its way through to demand in the economy but unfortunately it's not sustainable unless he thinks of some new ways of financing it. Now how he says it, we'll wait to see. He won't put it as starkly as that but in short, we're not going to have as easy a time as we've had over the past two or three years and the present level of consumer spending is going to slow down and he's got to work out how on earth he can finance a reasonable level of public spending that he can sustain.

Question: What would you do about public spending?

Ken Clarke: I would never have gone in for these three year spending plans and I certainly wouldn't have had a three year spending plan now. But the government of course has committed itself to producing figures in 2002 which they will allegedly stick to all the way through to 2005. So right now they've got to go through the motions at least of producing tablets of stone which are their public spending plans all the way through to the next election. And in the present uncertain economic climate I personally think that's a foolish thing to do.

The first thing I would do would be to go back to a year by year public spending survey and adjust public spending according to economic circumstances. I still think it was a serious mistake that Gordon Brown made to move away from that. If he does stick to three years I'd be very cautious indeed because I do not think you can just give in to all the spending demands from Gordon's colleagues in Cabinet and all the pressure groups outside and promise everybody a great prize for another three years when you don't know whether we are going to be able to maintain reasonable growth of the economy.

I think you can anticipate that Gordon's revenues will be much less than he was expecting and you can expect that his expenditure will rise because of rising levels of unemployment. I assume they're going to run a budget deficit for the next year or two, you always do in a slow down but that itself doesn't matter.

Question: Our debts are lowest among the G7 countries so that doesn't matter so much does it?

Ken Clarke: I don't think that's got much to do with it at all. Gordon paid off a lot of our national debt by accident, he didn't intend to, because he underestimated his revenues two or three years ago. It's a very eighteenth century way of looking at things to pay off debt for its own sake. But I agree, our proportion to GDP makes our national debt not itself a problem. But what you can't do is run enormous fresh public borrowings for any length of time. You should be keeping reasonably healthy, reasonably balanced public finances over the cycle. When the economy slows down you will have a deficit - it's one of the things that smoothes it out, because it helps you cope with the loss of tax revenues and you find yourself financing increased social security payments caused by rising unemployment. But what you can't do is pile on massive increases in public expenditure on top of that, unless you're prepared to pay for them, without squeezing out private investment and consumption and, in the medium term, making a debt problem. You should not go in for huge levels of public sector borrowing over and above the ordinary increases that you'd expect in a time of slowdown.

Question: Do you believe foot and mouth and September 11 have affected the Government's economic growth targets?

Ken Clarke: Well the economy is slowing down mainly because we're seeing the end of the American boom, with the Americans going through boom and bust. We are being affected by the general slow down in America, the general slow down in Western Europe, we have an over valued pound, we have an unsustainable current account deficit as a result of the over valued pound, and so we're going through a period of economic slowdown caused by that.

Now on top of that, what September 11 brought was a really bad blow to anything to do with civil aviation and anything to do with tourism. Foot and mouth brought a really bad blow to anything to do with agriculture and rural and domestic tourism. And so those blows just help to make worse a situation that was already deteriorating. Listening to Gordon Brown two or three years ago, he thought he'd abolished the economic cycle. Well, he hasn't abolished the economic cycle - we're going into a downturn now, perhaps a slightly sharp downturn because the Americans allowed such a crazy boom to get out of control a couple of years ago. But added to that you have these particular disasters that have hit us like foot and mouth and the World Trade Centre which are holes in the head we didn't need right now.

Question: What are the pressures of a downturn like for a Chancellor?

Ken Clarke: The pressures will be a very difficult public spending row which he's made more difficult by insisting on having this three year plan. So he'll have a queue of colleagues getting the ear of the Prime Minister telling him that never mind all of Gordon's hard nosed nonsense, what the readers of our newspapers wish to read is that we're keeping on spending more and more money because we have persuaded the public that spending more and more money will one day make their services better. And the job of the Chancellor of the Exchequer is occasionally pointing out to your colleagues that two and two make four, that there are quite a few external circumstances that affect what you can do and just playing popularist politics can't go on for ever.

Question: There are reports that the Prime Minister and the Chancellor have had a bit of a tiff. There were reports too that Margaret Thatcher and Nigel Lawson clashed too. Isn't it the case that there's always going to be a tense relationship between these two players and they clash from time to time. Did you ever have tiffs with John Major?

Ken Clarke: Yes I think the job as Prime Minister and the job as Chancellor make it inevitable that strain is going to occur between the two, it's bound to happen. They've slightly different agendas and they've slightly different tasks to play in government. John Major and I were personal friends which was very important because it meant that we were able to overcome all the strains.

Question: Blair and Brown are.

Ken Clarke: Well they started as friends, yes. And John and I were when we started and we were when we finished. At times we irritated each other quite a bit - we were bound to. The Prime Minister has got the political job of heading up the government, he's got an election to fight, he's got difficult colleagues on his back and he wants to have something popular to say, and as I was saying, the Chancellor comes in and says two and two makes four, we can't afford it, we can't do it, and quite apart from satisfying all these pressures on us we've got to run economic policies that keep UK limited and the real economy in a healthy state. And so you clash and the Prime Minister will sometimes think that the Chancellor doesn't understand politics anymore, and you've gone native to the Treasury, and the Chancellor will sometimes think that the Prime Minister has lost all ability to reason, but in the case of John and myself we never really got beyond irritation. We both knew that if we did not keep our good relationship we would bring each other to disaster. And I think our friendship and perhaps the way we handled it on both sides meant we never came to political blows.

Margaret Thatcher and Nigel Lawson were not on speaking terms at the end. They had been very close politically, never quite so close personally I don't think, but Nigel Lawson was really one of Margaret Thatcher's key supporters in the early years of the government and almost her right hand man. By the end of their relationship they were not speaking to one another. They were on furious terms. He was going to resign. The interesting thing about Margaret and Nigel was how they kept their disagreements such a secret. They may have refused to speak to each other or shout at each other in private but I was a fellow member of the Cabinet and it was only afterwards that I discovered just how bad things had got. I had not noticed the serious trouble.

Now the thing about Brown and Blair is exactly the same process - they were friends when they started, they claim they are having a terrible time now, and it's a feature of New Labour that they tell the world.

Question: Is that dangerous for the economy?

Ken Clarke: Yes. It damages confidence in the management of the economy. Not seriously but it's dangerous for the Government. Although Blair and Brown of course keep up appearances like a married couple on the verge of divorce, their entourage are spending their entire time when they're not running the country, ringing up journalists to tell them how outrageous the leader of the other court is. They're so obsessed with newspapers and public presentation that they have been fighting this bitter squabble in public by allowing their teams to brief against each other.

In recent history when you look at when the Prime Minister and Chancellor have come to breaking point, one contrast is really how comparatively discreet Nigel and Margaret were in keeping their flaming rows to themselves. The only person who I think was really fully aware was Geoffrey Howe and he was having his own flaming row but he too kept the full extent of that secret. But with New Labour, they can't have cup of coffee without it being all over the newspapers if they can find some way of spinning it and they're cheerily conducting their quarrel through their favourites columns of the press.

Question: Blair and Brown are rumoured to be at odds over tactics towards the euro. What would you like Tony Blair to be saying about the euro?

Ken Clarke: Well I think he ought to repeat more frequently the arguments in favour of joining the euro in principle. I think Blair's position is the same as mine - that it would be in the interests of the United Kingdom and the British economy to join the single currency when the economic conditions are right. I actually agree with the Prime Minister that the conditions aren't right yet but we're not too far away. And before the time is reached when we can join and go to a referendum, he really ought to more consistently explain the economic and the political case for joining.

Question: So take greater leadership on the issue?

Ken Clarke: Just remind people there is an argument. We are opposed by fanatics and there is a euro sceptic case put before 70 per cent of the readership of the daily newspapers twice weekly. If you're going into a referendum, every now and again you do have to remind the public that there is a serious other side to the case. But perhaps because of the problems with the Chancellor, I don't know, the Prime Minister makes occasional speeches making it clear that he remains convinced and gives some of the reasons why but he doesn't persist with it. At the moment, because I understand that he is rather occupied with other things and with the international outlook as well as the British outlook, with this uncertainness it is rather more difficult than usual to judge when the economic conditions may come right. But he ought to make the case more and explain why Tony Blair, Gordon Brown, I and most of the leaders of trade and business in this country, believe that we should seize the opportunity when it arises.

Question: Do you believe a referendum will finally lance the Tories' euro boil? Ken Clarke: I do hope so, I have to say, and I think it should. I've long believed that the Conservative Party won't find it easy to reach some stability until a referendum on the single currency decides the issue one way or another.

Question: Do you believe your views on Europe lost you the Tory leadership contest?

Ken Clarke: Probably. But before we go further into this I do get, until the Prime Minister opens up the season, I do get fed up about being interviewed about Europe all the time, and one of the weaknesses of the Conservative Party at the last election was its obsession with Europe. The extraordinary save the pound campaign was the reason why we lost so heavily. We would have lost anyway but no doubt it was made worse.

And I think a few weeks after that campaign had been fought, the Conservative Party was still paying a very great deal of attention to Europe. Iain Duncan Smith's now appointed all those euro sceptics to the Front Bench and told them all to shut up about Europe. Being interviewed by you, I'm rather inclined to agree with that! It would all do us a lot of good if we talked about it less. Meanwhile as I am pro-European I think it would actually do preparations of the referendum a lot of good if the Prime Minister and members of his government would make the case for the euro rather more consistently. Although I suppose Tony would say that every time he mentions it, a great section of the British press goes into hysteria again so maybe that discourages him from making the case too frequently.

Question: Did you fight a good leadership campaign or do you think you could have fought it better?

Ken Clarke: I thought there was nothing wrong with my campaign at all. I know people do make mistakes, but I think the people working for me ran an excellent campaign, everybody enthusiastic, many of them young and bright people very interested in politics. I think to go out on the stump as I did was correct. Obviously before that, I'd started with interviewing all my colleagues in Parliament and not really emerging in public because I was having long interviews and sessions with Members of Parliament. At the first stage they were going to determine who would go on to the last two. That succeeded and then I just went on the stump on a rather American-like a whistle stop tour which I describe as my Baedeker tour of the Conservative Party and I think that was the only way to campaign.

Question: Do you think the leadership contest ran well or could the rules be improved?

Ken Clarke: I think Iain Duncan Smith and I agreed at the time that it should never be allowed to take so long. It was complete folly to allow it to take eight weeks. The country decides on a government in three weeks. But the Conservative Party couldn't produce a new leader in less than eight weeks. Worse still, the eight weeks coincided with the silly season in the newspapers when all the serious journalists have gone on holiday and their deputies have got nothing to write. And so we were just used as an object of entertainment by the newspapers of every political colour throughout the eight weeks.

Question: Were you surprised by the result?

Ken Clarke: I was disappointed, I wasn't totally surprised. I started the campaign thinking I was unlikely to win. During the campaign I got more optimistic as it went on, and then when I found out I'd lost I went back to where I'd started, saying well it's silly to think that I was likely to win. If I had thought I hadn't had a chance of becoming leader I wouldn't have bothered standing but I wasn't too surprised to lose.

The selectorate to whom I was appealing were people who, as activists, had been engaged in the save the pound campaign only a few weeks before. Now I was explaining that I wasn't asking them to change their opinion but I was asking to have a more tolerant and open attitude on the subject. I think it was a quite a step to ask them to take. Most of the electorate were elderly people who pay their subscription and never attend meetings and sent in a postal ballot after reading the Daily Telegraph. It was quite hard work getting their votes.

Question: Will you be staying in the back benches or would you consider a front bench position or will you leave Parliament?

Ken Clarke: I am enjoying being a freelance backbench Member of Parliament. And neither William Hague nor Iain Duncan Smith has indicated otherwise. I think I'm going to continue to enjoy my role as a backbench member of Parliament.

Question: So if Iain Duncan Smith offered you a job would you take it?

Ken Clarke: It depends what job and depends what he expects me to say about the policy of the Party.

Question: But you'd never say never?

Ken Clarke: Never say never in politics. I think one of the biggest mistakes is Iain saying never to the single currency. But I'm not wanting to go on the front bench. I'm not expecting to go on the front bench and I'm perfectly absorbed in politics doing what I'm doing as a back bencher.

Question: What do you make of the Home Secretary's anti terrorism legislation?

Ken Clarke: Well the key and most difficult issue is the question of whether you should intern without trial people who you're informed by the security services are planning or engaged in terrorism. I do support that, although it's a very difficult issue and by far the most important one in the bill.

I do think there are cases that I experienced when I was Home Secretary when the security services were able to satisfy me that someone living in this country was actively engaged in preparing or supporting terrorism. You have no evidence that you can call in court because you have to call evidence from the security services which would reveal their sources of information. All attempts to arrange with the British courts for security services' evidence to be given in ways that protects national security have proved fraught. If they're foreign nationals and have compelling information, you should be entitled to take them into custody if you can't deport them. Again the courts here make it very very difficult to deport them if you can't produce the evidence which will satisfy the high burden of proof. Internment is very difficult for a country of this kind with our legal traditions to take but I think we have to do it in the interests of protecting the very values that we are talking about so long as there is some type of check on the Home Secretary's use of his powers.

So long as we have some adequate body headed by, I hope, a judge, who have the power to overturn the Home Secretary's decision after reviewing the information on which the Home Secretary is relying, I am content to accept that. I regard myself as a very liberal man and in the last Parliament I was furiously attacking the government for its attempts to restrict jury trial. But there's no doubt in today's world London is getting the reputation as a safe haven for terrorists. They like living here. One of the things they like is our legal system where it is so difficult to do anything, despite what they're doing, and in a few cases where the security service is able to produce information which would satisfy the most doubtful Home Secretary, I think he has to have that power in the interests of all. Of course the Home Secretary has a heavy responsibility to protect individual liberty, but he also has a responsibility to protect people against being blown up in the aeroplanes being hijacked or the buildings being bombed. He should be able to act on sound information that he is given which could prevent an outrage in this country or abroad.

So that's my view on the key thing and I've supported the government on that and I voted for the Bill on that basis. What the government has then done is throw in the kitchen sink - including all kinds of old Home Office ideas for improving the criminal law on all sorts of areas. Most of them I agreed with - like making it a criminal offence to bribe officials from overseas governments. But they've taken the opportunity to say this is all against terrorism so let's rush it through the House of Commons without too much embarrassing debate - it doesn't look good in newspapers if people criticise us and divides our party. So I voted for the Bill but I voted against the timetable.

The only thing I disagree with, unless I'm persuaded during the debate, is the idea to make it a criminal offence to incite religious hatred. I think that allows all kinds of fringe sects to exploit that. But other than that, I voted against the timetable because I do think this is a difficult area. There needs to be great care and I think the idea that law has to be rushed through the House of Commons in three days flat is nonsense - that's Alastair Campbell's media management, that's not national security. It's only that they want to cut back the amount of debate that they have about it and they pretend to look tough without anybody to be able to point out that these are quite difficult issues.