The Faustian pact the coalition made with the Bank of England and the markets has not worked. It's time to end austerity and use fiscal policy to revive Britain

Faustian pacts are not a good idea. On assuming office in 2010 the coalition entered into a pact with the Bank of England and the financial markets which ranks as one of the most ill-conceived ventures in economic policy by any British government since the second world war.

It was to be deficit reduction – indeed the elimination of the so-called "structural" deficit – by 2015, in return for supportive monetary (including exchange rate) policy from the Bank of England and the enthusiastic backing of the financial markets. The sine qua non as the criterion for success of this policy and pact was to be a marked improvement in the pace of economic recovery.

The chancellor, George Osborne, made a bad start by raising VAT – a £12bn blow to consumer spending, with additional multiplier effects. The economy the incoming government inherited was recovering, albeit slowly. But the combination of the perverse increase in taxation (knocking almost 1% off gross domestic product per annum), and the impact of the austerity programme was sufficient to stop the recovery in its tracks.

This added to the deflationary impact of higher import prices arising from the massive – but necessary – devaluation of the pound in which the Treasury and the Bank of England had acquiesced. Then there have been all the other depressing influences on real incomes of which the governor, Sir Mervyn King, recently complained.

I should emphasise that paradoxically, an increase in energy prices can be inflationary in that it affects the general price level and deflationary in that, via the impact on real incomes, it has a depressing effect on spending power and therefore economic activity. Thus the monetary policy committee can be criticised by purists for not hitting the official inflation target of 2%, yet praised for not taking its brief too literally, and aggravating the depression.

For depression it is: in common with the redoubtable Jonathan Portes of the National Institute of Economic and Social Affairs I have regarded the term depression appropriate to a situation where output continues to remain well below its previous peak, let alone the 15% or so by which it is below what the historical trend would indicate.

In a paper which I recommend to all ("How to Restore Growth and Cut the Deficit, The Policy Consequences of Revived Keynesianism, Lombard Street Research") the economist Christopher Smallwood reminds us of Keynes's definition of depression: "a chronic condition of subnormal activity without any marked tendency either towards recovery or towards complete collapse".

Although things are pretty bad, we have certainly avoided complete collapse – so far! The role of Gordon Brown and others in "saving the world" in 2008-09 was vital in preventing disaster then. Central bankers since had either read or heard about Liaquat Ahamed's book Lords of Finance about how their predecessors got it so wrong in the 1920s and 1930s. Through quantitative easing – open market operations to offset a private sector credit crunch by easing monetary conditions – the central banks have stopped the rot.

Quantitative easing was urged way back by Keynes in order to lower interest rates. But it was when monetary policy was ineffective – like "pushing on a string" – that Keynes advocated what have come to be known as "Keynesian" policies – the use of fiscal policy (government spending) – to revive activity.

Unfortunately, under the Faustian pact we have witnessed a double whammy: fiscal policy being used to reduce government spending when the economy is already depressed. And a monetary policy that has been pushing on a string.

As Smallwood points out, the Treasury and Bank drew the wrong conclusion from the apparent success of the combination of fiscal contraction and monetary expansion in the 1980s and 1990s. "In both cases, the contractionary impact of tax rises and spending cuts was counterbalanced by substantial falls in interest rates, and of the sterling exchange rate at a time when our export markets were growing," he writes. Exports and investment took up the slack left by budgetary cuts.

This time there was not much further for interest rates to fall. Indeed, banks were widening their margins and many borrowers did not feel the intended effects. For some, interest rates actually rose. Moreover, despite the more competitive pound, the sluggishness of our main markets prevented an export boom.

George Osborne cannot bear to admit he has been wrong, blames the Bank, and produces a Canadian ex machina in the shape of Mark Carney. And so far from pleasing the financial markets with this austerity programme, he finds they are more concerned about lack of growth, or continuing depression. Indeed the markets showed signs of incipient panic when they learned last week that King himself wanted more quantitative easing at the last meeting of the MPC.

Now, following recent work on the operation of "fiscal multipliers" in the US, Smallwood argues that a switch to a policy of fiscal expansion is the only way out. The multiplier was a discovery of the economist Richard Kahn's, which Keynes adopted. Normally economists think of additional public spending or tax cuts having "multiplier" effects, as the person or institution in receipt of extra funds spends them in a way that boosts the incomes and spending of others. Similarly, higher investment produces what economists call "accelerator effects".

But at present we have very damaging negative multiplier effects, in which budget cuts lead to obvious hardship, to further reductions in people's ready cash and consequent social problems.

Smallwood argues convincingly that fiscal policy needs, selectively, to be put into reverse. "A properly designed fiscal stimulus could restore growth, at the same time generating powerful tax flow-backs from (a) national income (multiplier effects); (b) higher private investment (accelerator effects); and (c) improved long-term growth potential as a result of increased investment."

There is a huge range of potential infrastructure projects out there. They can pay for themselves. The only way out of this mess is a complete reversal of fiscal policy. It would be seriously ironic if the financial markets ended up punishing this country for the unintended consequences of a Faustian pact that was meant to please them. The ratings agencies have already started.

As housing minister, David Cameron's hero created 300,000 homes. As prime minister, he fired cabinet members without compunction. There is much we can learn from him still

When someone told me that Sir Mervyn King wanted to break up the bank, it was tempting to think he might be referring to the Bank of England. The governor has been put in an unenviable position by the way the chancellor has been so openly favouring his successor, Mark Carney, and King is becoming increasingly outspoken.

The putative plot thickened when we learned that some RBS cash machines had seized up: but there is no evidence that this was the next move in the outgoing governor's welcome assault on RBS.

Meanwhile, back at the ranch, we learned that the Carneyisation of monetary policy will be a central feature of the budget on 20 March. "Osborne to hand Carney powers to kickstart economy," roared the Financial Times. It got better: "George Osborne's budget will pave the way for Mark Carney, incoming Bank of England governor, to come to the rescue of the economy as the chancellor sets the scene for a new era of looser monetary policy."

There you have it: such confidence! And what a magnificent example of the begged question – assuming what has yet to be proved! The chancellor's spinners are spinning out of control.

By "the chancellor", I am of course referring to George Osborne and not to business secretary Vince Cable, who tried in last week's New Statesmanto inject some fiscal sense into the coalition's lamentably misguided economic strategy.

Many observers have been urging the government to take advantage of rock-bottom interest rates to raise investment and demand in an economy whose depression has outlasted that experienced in the 1930s. Although he posed the problem as a "controversial" question, Cable made it pretty clear that the government "should borrow more, at current very low interest rates, in order to finance more capital spending". The list of possible, indeed desirable, projects includes the building of schools and colleges and "small" road and rail developments.

And then there is new housebuilding, which featured prominently in the economic recovery of the 1930s. The connection between the lack of housebuilding and the swelling bill for subsidised rents is all too obvious, and the blame for neglect of public-sector housing lies at the door of successive Conservative and Labour governments. Oh, sorry, I nearly forgot: this government, which is being so unpleasant towards the poor, is actually a coalition of Conservatives and Liberal Democrats.

But back to the budget. Harold Macmillan – Conservative chancellor in 1956 and prime minister from 1957 to 1963 – is one of David Cameron's heroes. As housing minister in the early 1950s he was celebrated for presiding over a major building programme, and his target of 300,000 dwellings was indeed achieved. If he were here today and consulted about the economic impasse, he would almost certainly tell the prime minister to sack his chancellor – Macmillan himself had no compunction in these matters – conduct an unashamed U-turn, and abandon the policies that actually restrict the growth Cameron says he is aiming at.

In preparing his budget speech, Osborne could do worse than refer to the one budget speech Macmillan himself delivered, on 17 April 1956. I would not recommend the two hours that Macmillan spent on his feet, but there are some great passages, including a quotation from the historian Macaulay's Essays to the effect that worries about debt and deficits go back centuries, yet "on what principle is it that, when we see nothing but improvement behind us, we are to expect nothing but deterioration before us?".

There is an interesting contrast between then and now. As Macmillan said, "monetary policy cannot 'go it alone'. It can only operate effectively in conjunction with fiscal and other measures …"

Now, Macmillan was talking in 1956 about "checking demand". He said "no one has yet found an easy way to restrict credit without higher interest rates". Fast forward, and today he would be talking about the need to boost demand, and complaining that "no one has yet found an easy way to boost credit with lower interest rates". That is to say, thanks to the banking crisis and its repercussions, quantitative easing may be boosting asset prices but not the credit mechanism that boosts demand.

Macmillan wanted to boost savings – and, memorably, introduced premium bonds. The current ineffective "rebalancing exercise" should be boosting spending, not savings.

Which brings us to an important lecture last week by Dr Sushil Wadhwani, a former member of the Bank of England's monetary policy committee, delivering the annual Peston lecture at Queen Mary, University of London.

Addressing the question "The great stagnation: what can policymakers do?", Wadhwani proposes a fiscal boost via what he calls "a money-financed fiscal expansion" – vouchers to stimulate consumption and temporary tax incentives to promote investment. Personally, I would add a cut in VAT.

Such a policy is known by economists as a "helicopter drop" – not manna from heaven, but money out of the blue. My question is: do we make enough helicopters these days?

The coalition is suffering the worst of both worlds: excoriated by the right for continuing to borrow, but not borrowing enough to bring about a recovery

A friend in the "penny off a pint" pub told me on budget evening that the economy was rebalancing well. "In my high street it is rebalancing towards betting shops, fried chicken outlets, pawn shops, Poundland and payday loans," he said. "And do you know what the payday loan shops advertise themselves with? 'The banks won't give it to you, but we will'." Yes, and at what rates of interest!

The "penny off" reminded me of budgets of the old days, but in this day and age it was a wonderful jape on the part of a government that thinks we all drink too much. Perhaps they have finally got the point that in the face of an increasingly irrational economic policy, the public just wants to drown its sorrows.

Sorry, did I say "irrational"? It may be irrational to us Keynesians, but we must never forget that Osborne's budgets are based on a political strategy that assumes the general public is gullible enough to accept indefinitely the misleading propaganda that our economic troubles are caused entirely by the profligacy of the last government, and the fallacy that when the private sector cuts back then so must the public sector.

You would not believe, to listen to this most dangerous of chancellors, that the so-called "structural deficit" inherited by the coalition in 2010 was no worse than the one inherited by Labour in 1997.

Gordon Brown and Ed Balls may have made the mistake of paying too much heed to the likes of George Osborne and thus placing faith in the financial sector that let everybody down, but they did not cause the worldwide collapse of bank lending in 2008-09 that precipitated the great recession and the first annual decline in world trade since the 1930s.

One's concern until recently was that the coalition had been getting away with its misrepresentation of causes, effects and required solutions; also, until recently, that while being very effective in criticising the government, Labour appears to have given the impression to most people that it does not have much of an alternative. "They would cut, but more slowly" has been the general view.

To judge from the standard of debate on the BBC's Question Time the day after the budget, Labour still has an uphill struggle to get across the fundamental point that it is not the borrowing that is the problem, but the prolonged depression and the way that the multiplier effects of budget cuts make the situation worse and hold back the recovery.

Output in this country is some 15% below what it would have been on past trends, and it is not true that the potential for economic growth in this country has come to a halt. What has come to a halt is the application of the lessons of the interwar years that governments have the fiscal tools at their disposal to revive demand.

In a sense this government is getting the worst of both worlds: it is excoriated by the right for continuing to borrow, yet its failure to boost demand and borrow more means that it is not taking the necessary action to provide what the governor-in-waiting of the Bank of England calls "escape velocity".

Mark Carney refers to monetary policy, but what monetary policy and the government's reluctant toleration of higher-than-intended borrowing have essentially achieved is not growth, but stabilisation at a depressed level.

Now there were some good, Heseltinian "supply side" efforts in the budget – we can pass over the chaos of the chancellor's housing measures – but, in macroeconomic policy terms their combined effect is marginal, as can be seen from the gloomy forecasts from an Office for Budget Responsibility that usually errs on the side of optimism.

It is a not-unfounded leftwing interpretation of what is going on that a nasty, rightwing government is using the pretext of a much-exaggerated "Labour mess" to cut back public services and the social safety net quite deliberately, in a way that is severely aggravating poverty, homelessness and hardship for many citizens. But not every backer of this policy has nasty rightwing motives. It is just that they are trapped in a mindset where they have been convinced that they will lose "credibility" with the financial markets if they do not persevere with the fiscal version of sado-monetarism. Yet as the failure of the policy becomes more apparent, and the prospect of growth recedes, they will find they will lose credibility anyway.

For Whitehall and City insiders, the centrepiece of the budget was the plan, wrapped in a mist of vagueness, to encourage the Bank of England to be more like the US Federal Reserve in taking account of unemployment as well as inflation, and giving the markets more guidance as to how long interest rates will remain low.

For Mervyn King and Mark Carney, the US Federal Reserve chairman Ben Bernanke is the exemplar. But, unlike Sir Mervyn, Bernanke did not commit himself to supporting an inappropriate fiscal strategy. The chancellor repeated in his budget speech that "active monetary policy and a responsible fiscal policy are two components of our economic plan". Unfortunately, monetary activism has its limits in a depression; and the fiscal policy is "responsible" in a different sense. It is responsible, as the OBR recently pointed out to the prime minister, for hampering the "recovery".

Whether or not the chancellor avoids presiding over a triple dip, the truth remains that he took over an economy that was growing slowly in 2010 and pulled it under

Exiguous rates of growth in the parts of the economy that austerity doesn't reach do not constitute a justification for the chancellor's chilling strategy. But be warned: a last refuge of the scoundrel will be to claim "Look! It was all worthwhile. Thanks to our necessary and unavoidable policy of austerity, the economy is in better shape and is growing again."

The chancellor and his supporters will gloss over the inconvenient truth that the economy was in fact growing again when they took over in May 2010 – goodness: was it less than three years ago? It seems more like a decade.

It was not the troubles of the eurozone that derailed the recovery. It was the dramatic impact on business and consumer confidence of an austerity programme based on a misleading analogy – comparing our "plight" to that of Greece – and a false premise, namely that monetary policy would offset the impact of fiscal cutbacks.

What monetary policy – low interest rates, quantitative easing and assorted gimmicks – has achieved is to prevent the degree of monetary contraction that aggravated the depression of 1929-31. Even so, such is the continuing state of the banking system that even an enlightened monetary response has severe limitations.

There are moments in economic policy when governments make such obvious mistakes that even those of us who were taught always to see the alternative point of view wonder whether we are just "seeing things".

The most egregious cases often concern changes in what is known as indirect taxation, of which the most conspicuous element is VAT. Thus a rightwing commentator recently praised the Thatcher government for having "conquered" inflation after inheriting a rate of 10% from Labour in 1979.

What this revisionist omitted from the story was the way that, by almost doubling the rate of VAT for most transactions, the new government aggravated the problem. The conquest began a year later, by which time the year-on-year rate had peaked at 21.9%.

And in Japan, in the mid-1990s, the government of the time put an abrupt stop to an economic recovery by almost doubling VAT.

The big mistake the present British government made was again related to VAT: by restoring the rate to 20%, Osborne deflated the economy by close to 1% of gross domestic product, thereby taking it back into a recession whose length and consequences have justified the phrase "prolonged depression".

So here we are, with a public mood of resignation to prolonged austerity, and a chancellor who hopes that with the reappearance of even an exiguous rate of economic growth he will have fooled people into accepting that it was somehow all worthwhile. The ultimate in defeatism is manifested by those who complain that the economy has not responded enough to the biggest devaluation since 1949.

So what would your correspondent do? The first thing to establish would be that, although the trade and balance of payments figures are bad, there is no need for a devaluation: we have already had one of 25%. Because of the immediate effect on import prices, necessary devaluations tend to make the trading picture look even worse before it gets better – the J-curve effect. That is what has been happening. But, albeit slowly, there is evidence that the manufacturing and service sectors are finally waking up to the opportunities.

Traditionally, in order to make a devaluation work, the government has to "make room" in the economy by depressing domestic demand.

In present circumstances, however, there is no reason to do so. Our economy is so depressed, and operating so far below capacity and potential, that a major boost to domestic demand is necessary, and could be effected by a cut from 20% back to 17.5% in VAT.

This would have a more immediate effect than the longer-term infrastructure projects currently proposed – which are also necessary and for which there is also plenty of room in our depressed economy. These can be financed very cheaply: indeed, in many cases they are investments that will pay for themselves in due course.

The most important investment of all has to be in the sort of ambitious housing programme – no fewer than 300,000 new dwellings a year – that Harold Macmillan pulled off in the 1950s.

It becomes increasingly obvious that the bill for housing benefit is the consequence of neglect of housebuilding by successive governments, starting with Thatcher's. We see the pernicious social effects in the way cuts in benefits and the "bedroom tax" are disrupting so many family lives.

We need a secretary of state for housing (and nothing else) in the cabinet. Macmillan is reputedly one of the present prime minister's heroes. He should go for it!

Far from being a time of economic miracles, growth in the 80s was no better than it was in the 70s: and inflation was conquered only by the effects of a long and damaging recession

In The Man Who Shot Liberty Valance, Ransom Stoddard (played by James Stewart) goes to great lengths, many years after the event, to explain to the local newspaper editor that it was Tom Doniphon (played by John Wayne) who did the deed, not himself. But the editor tears up his notes and declares that he prefers the legend to the facts.

It has been like that following the death of Margaret Thatcher, with the latter in the role of "The Woman Who Transformed the British Economy". As one who chronicled events from 1979-90, I have to say it did not feel like that then and does not feel like that now.

One would expect a "transformation" of the economy to show up in the statistics for economic growth. But what the facts show, as opposed to the legend, is that the annual rate of increase in GDP between 1980 and 1989 was 2.2%, exactly the same as the 2.2% per annum recorded between 1970 and 1979, the decade when everything was supposed to be going to pot.

These statistics come from the late Christopher Johnson's balanced assessment of a most controversial period, The Economy under Mrs Thatcher 1979-1990. Johnson concludes: "Mrs Thatcher is likely to go down in history more for her political and military than for her economic and social record." As for "lasting" effects on economic growth, the average growth of GDP since 2005 has been an exiguous 0.6%. Some transformation!

There was always something bogus about Thatcher. The prayer she quoted in 1979 about peace and harmony was the work of a French cleric during the first world war, and had nothing to do with St Francis. Harmony was the last thing Britain's first woman prime minister brought to her country.

Unfortunately, the sale of council houses at knockdown prices, while popular, led to no serious attempt to build more social housing – this didn't fit with the dogma – so the seeds were sown for the housing crisis of today.

Productivity was generally considered one of the successes, but this was less a case of a miraculous industrial revival than of a higher batting average because fewer people were playing. I recall asking whether, in their obsession with small business, it was the Thatcherites' ambition to turn every large business into a small one.

The problems were evident from the beginning. Having inherited an inflation rate of 10% in 1979 and promised to halve, if not eliminate, it, Thatcher presided over a policy – monetarism – which, far from conquering inflation, was so ineffective that within a year inflation had risen to almost 22%. Thanks to the worst recession since the second world war, the year-on-year rate of inflation was down to 3.7% by the time of the 1983 election.

It was not just dead industrial wood that was lost: many thriving firms went under. At one stage, the chairman of ICI asked Thatcher whether, given the squeeze, she wanted firms such as his to remain in Britain.

Thatcher was the most unpopular prime minister since records began – until the Falklands war. She was lucky to win the 1983 election, because the opposition was split, thanks to the breakaway from Labour by the Social Democrats – who, if they had stayed, might have helped to dissuade Labour from running on a vulnerable ticket.

Apart from trade union reform and misleading achievements in productivity, the Thatcher period was noted for offering privatisation not only to this country but to the rest of the world. Some was good; some was bad.

But the gravamen of the economic charge against her is the neglect of manufacturing industry. Although output did grow a little over the period, our performance was far more sluggish, vis-a-vis the rest of Europe and the wider OECD area, than you would think from all the crowing about economic "miracles". As Jim Prior, her first employment secretary, wrote of his monetarist colleagues: "Their attitude to manufacturing industry bordered on the contemptuous. They shared the view … that we were better suited as a nation to being a service economy and should no longer worry about production."

Having created an unemployment crisis in order to reverse the (largely) self-inflicted doubling of inflation, the Thatcher government proceeded to create a "dependency culture", massaging the figures by encouraging the jobless to claim disability benefit.

Privatisation hardly figured in the 1979 election. It was subsequently seized upon as a diversion from the wider failure of economic policy and a useful source of revenue. But the most adventitious source of revenue was the North Sea – a source to which one Thatcherite would refer as "what we are using to finance unemployment".

Poverty increased dramatically, as society became more unequal, and the postwar consensus was destroyed. As the sacked cabinet minister Lord Gilmour observed: "The sacrifice imposed on the poor produced nothing miraculous except for the rich."

Eventually, we had the Lawson boom, with inflation back to 10%, and, all other panaceas having failed, recourse was had to the Exchange Rate Mechanism to control inflation.

Well before the poll tax and the difficulties over Europe, the impression gaining ground in her cabinet was that the prime minister was showing signs of going off her head. The manner in which she behaved, and, finally, the way her cabinet colleagues responded, poisoned the Conservative party.

No wonder they prefer the legend.

Britain is in a depression. Cuts won't cure it. And there's so much we could be spending money on

The government and the nation desperately require a Plan B. If our obstinate chancellor is not prepared to own up to the need, then he should have words with his prime minister about his interest in another cabinet post and leave the door open for a more expansion-minded colleague.

Two names that come to mind are Lord Heseltine and Kenneth Clarke. Both have had to pay lip service to the chancellor's "austerity strategy", but it is obvious from the conclusions of his recent Downing Street-commissioned report on growth what Heseltine really thinks of Plan A. And Clarke knows that the way to achieve a reduction in the deficit is by encouraging the economy to grow at a decent lick – not add to private sector cutbacks with public sector ones on top. This is what he achieved during his 1993-97 chancellorship.

Alas, at 80 Heseltine would probably not want the job, and Clarke is far too unpopular with the Thatcherites who, along with Ukip, have now frightened that nice David Cameron into ditching his attempts to soften the Conservative party.

George Osborne's shamelessness knows no bounds. The ratings agencies were going to be the judge and jury of his pre-Keynesian strategy. They have given their verdict. The American academics Kenneth Rogoff and Carmen Reinhart had in theory demonstrated that borrowing and rising debt levels caused low (or no) growth, but rival academics have now demonstrated that their research was deeply flawed: the causality is the other way around.

When elaborating on his austerity strategy in the Mais Lecture of 2010, Osborne drew putative justification for his policies from the work of Rogoff and Reinhart. It is, by the way, with some amusement that one now finds the two academics proclaiming: "Our consistent advice has been to avoid withdrawing fiscal stimulus too quickly, a position identical to that of most mainstream economists."

The question is whether a fiscal stimulus should be withdrawn at all before a decent economic recovery is established. For all his previous fiscal sins – and they are not nearly as grievous as they have been painted – Gordon Brown realised this. The error made by policymakers in the UK and the eurozone has been, in the words of Sir Samuel Brittan, to return "to old habits" after the rescue operation of 2009-10.

Osborne has admitted, indeed boasted, that his model was Geoffrey Howe's budget of 1981, which – according to mythology – produced a dramatic recovery by cutting public spending and raising taxes. Osborne rescinded Labour's cut in VAT and began a public spending squeeze, the consequences of which are all around us – with more to come as the Treasury completes a new spending round for the year 2015-16.

The 1981 fiscal squeeze did not produce a recovery; but the economic cycle eventually turned up, helped not least by the budget strategy of easier monetary policy and an engineered fall in the pound. Then came the abolition of credit controls. Even so, unemployment went on rising until 1986.

An important difference between then and now is that we now have a banking crisis. Also – as former Treasury official Sir Tim Lankester pointed out at a seminar on 1981 last week organised by the Treasury and the Mile End Group – consumer debt was much lower then than now.

All this talk about double dip or no double dip is a red herring. The fact is the economy remains in depression, with gross domestic product some 15% below what previous trends would suggest possible.

Now, controlling and curbing the growth of public spending is in the Treasury's DNA. But this is not the time for further cuts; indeed, it is time to reverse the process by which youth programmes, school sports facilities (so much for the Olympic spirit) and many local social services are being emasculated.

The pressure for economically unnecessary, indeed socially harmful, cuts has become so intense that furious cabinet ministers in other departments are urging the prime minister to break his commitment to "ringfence" the health service.

The absurdity of the situation was vividly brought home to me by the wonderful NHS surgeon who recently operated on my left shoulder after I had tripped on a pavement: London teaching hospitals are noticing a significant increase in admissions to accident and emergency as a result of falls connected with unmended pavements and potholes.

It is the economics of the madhouse for local authorities to be in this position, thereby adding to the pressure on the NHS.

How about government grants of, say, £2m per local authority, to be spent specifically on mending all those potholes and pavements, on condition that the money has to be spent by 30 September 2014?

Even Francophile Conservatives now want Britain to go it alone. But it's not the euro that's holding us back: it's the government

According to Greek mythology, Cerberus was the many-headed hound that stood at the gates of Hades, the underworld. Feeding the hound of hell was a thankless task. He always wanted more. Hence the expression "a sop to Cerberus", meaning a futile gift of a morsel that only leaves the hound baying for more.

I am not suggesting for one moment that Ukip or the Tory party are dogs. But the expression "a sop to Cerberus" – much favoured by my classics master in days gone by – does keep coming to mind, with our beleaguered prime minister in the increasingly frustrating position of delivering the sops.

Mythical history does not relate whether there are also pigeons at the gates of Hades. But if there are, my old friend Lord Lawson has certainly thrown a cat among them with his Ukip-style call for us to leave the European Union altogether – he who himself lives a fair proportion of the year in la belle France.

Lawson likes the way of life in France. So do many of us, who seize every opportunity to relish it – unlike, it seems from recent opinion polls, the French themselves, who are not as content as we thought.

It was admiration for the standards of the French and other European health systems that prompted New Labour to devote a fair proportion of the budget to modernising our own NHS. Further back, envy of what was perceived as superior economic performance was one of the main reasons why our nation applied to join what was then the Common Market.

Whether they vote Conservative, Labour or otherwise, the British people are fundamentally conservative. In the 1975 referendum they always seemed likely to vote to stay in, rather than take a leap outside. And, whatever the opinion polls show now, I suspect that if this new proposed referendum ever takes place, there will once again be a vote for staying in. But what a lot of time would be wasted meanwhile!

As older readers will know, I have always regarded the EU, for all its irritations, as what the authors of 1066 and All That would have described as a Good Thing. But the eurozone was a step too far, and it is to the credit of John Major that we "opted out" and to the credit of Gordon Brown that Tony Blair's pressure to join was resisted.

The ultimate irony was the spectacle last week of David Cameron, in his capacity as this year's chairman of the G8, representing the EU in early discussions with President Obama about a proposed free trade area with the US, while back home his MPs and even ministers were calling for our complete withdrawal from the EU.

As the president reminded Cameron, it is in the UK's best interests to remain in the EU. He could have added that membership of the EU and exemption from the eurozone gives us the best combination.

Freedom from the constraints of the single currency has enabled us to secure a devaluation that, according to the latest estimates from the Office for Budget Responsibility, produced a gain in net trade (exports minus imports) equivalent to 2% of GDP between the fourth quarter of 2007 and the fourth quarter of 2010. Recent figures have not been so good, but have been distorted by the vagaries of production of North Sea oil. The governor of the Bank of England, Sir Mervyn King, pointed out last week that since 2007 and the devaluation, the trade deficit (excluding North Sea oil) has averaged 1.5% of GDP compared with 3% before.

Such exchange rate adjustments have not been available to the suffering southern states of the eurozone vis-a-vis super-competitive Germany. Nor, for that matter, have they been available to France. Moreover, the weaker eurozone economies have been further debilitated by austerity programmes that derive partly from the Teutonic belief that suffering does lesser economies good and partly from the way the bond markets panicked until Mario Draghi, president of the European Central Bank, promised to do "whatever it takes" to keep the show on the road.

The bond markets have now woken up to the deficiencies of the austerity model. The fundamental flaws of the way the policy operates in the eurozone are well explained in the latest weekly comment from Russell Jones and John Llewellyn of Llewellyn Consulting. Coming from analysts who, unusually for this country, have been broadly friendly towards the eurozone project, their questioning of the long-term sustainability of the eurozone, on account of the asymmetrical way the rules operate, ought to be taken seriously in Berlin and Frankfurt.

What makes the British economic situation so frustrating is that we are not subject to the deflationary bias of the eurozone: George Osborne and his pals have simply imposed one of their own, inventing imaginary threats from the bond markets.

The cuts in social security have been especially severe for the poorest in our society. Yet, as the Child Poverty Action Group points out, the poorest spend a larger proportion of their income than other groups, and the cuts have multiplier effects that hardly encourage that elusive recovery. The cuts are not only damaging in themselves: they are what Tim Nicholls of CPAG calls a "fiscal hindrance" to economic recovery.

What a convenient diversion from the damage caused by the chancellor's economic strategy all this nonsense about leaving the EU is.

Even traditional bastions of austerity such as the IMF are starting to see the error of their ways. Only the chancellor, and Liberal Democrats 'bored by economics', continue to deny the truth

Had Keynes not been cremated, the policies of austerity pursued in this country and the eurozone since 2010 would no doubt have had him turning in his grave.

Thanks not least to Gordon Brown in 2008-09, the teachings of Keynes were briefly rediscovered. Unfortunately the international coordination initiated by Brown and endorsed by Presidents Obama and Sarkozy did not last. Mistaking a banking crisis for a fiscal crisis, European leaders – including, not least, George Osborne – went for premature fiscal retrenchment, with results that were all too accurately forecast by critics.

In recent months even that traditional bastion of fiscal tightening, the International Monetary Fund, has seen the error of its ways. But Osborne ploughs on, with another round of spending cuts planned for later this month, while every day the media report the hardship and disruption to families caused by cuts in social security and housing benefits that are economically unnecessary.

In his desperation, the chancellor has been economical with the actualité both about the IMF's general criticism and in particular about its views on how and when the nationalised banks RBS and Lloyds should be returned to the private sector. The IMF does not approve of a hasty return, with shares sold at a knockdown price, in the interest of giving an early and minor boost to the short-term budgetary position.

In which context, the retiring governor of the Bank of England, Sir Mervyn King, is being accused by those who were at the coalface of rewriting history when recently claiming that he had a bigger and better plan for rescuing the banks than the one with which the Brown government came up.

This is hotly disputed by both the Darling and the Brown camps, who are also bitter about the role King played in supporting the coalition's deficit reduction strategy.

Now, there is nothing sinister in governors having confidential discussions with opposition leaders, whether or not they are in the process of forming a coalition. One recalls how Chancellor Kenneth Clarke was perfectly relaxed about letting the then governor, Eddie George, have discussions with the Brown-Balls team in the runup to the 1997 election.

Indeed, it is one of the more attractive aspects of the unwritten British constitution that such discussions can take place. But an undoubted source of grievance between Labour and the governor has been the way that King – whose brief was, and continues to be, monetary policy – was seen to add fiscal policy to his armoury of advice.

Not that Sir Mervyn had any responsibility for fiscal policy. But it is well known that privately, and to some extent publicly, he backed Osborne's ill-fated deficit reduction plan.

Osborne himself has from time to time made it clear that, in adopting this strategy, he was influenced by the view that the fiscal tightening that took place in Sir Geoffrey Howe's 1981 budget led to an economic recovery. In taking this view, Osborne displayed an unfortunate misunderstanding of the strategy behind the 1981 budget, which involved a major shift in policy towards easing monetary policy and lowering the exchange rate.

Even so, it is a myth that this rebalancing of policy led immediately to a recovery. Unemployment went on rising until 1986, and the UK was the only major OECD economy to experience a fall in gross domestic product in 1981. Moreover the eventual recovery depended on the abolition of credit controls.

By 2010, when this eccentric coalition was formed, we had already experienced a sensational devaluation, and there was precious little scope for an expansionary monetary policy.

The obvious thing to do – the lesson that Keynes had taught several generations, including those to which King and your correspondent belong – was to use fiscal policy as an expansionary device, to offset the contractionary effect of the depression. Instead, fiscal policy was, and still is, being used to aggravate those depressionary forces.

In Five Days in May, his invaluable book on the negotiations that led to the Conservative-Liberal Democrat coalition, Lord Adonis establishes that, to their eternal discredit, Nick Clegg – of whom we are told "economics bores him" – and David Laws of the Liberal Democrats were gung-ho for this anti-Keynesian strategy. So, it saddens me to hear, was my old friend Chris Huhne, once a solid Keynesian.

Although the nation is taking a long time to wake up to it, the result of the last election and the resulting coalition has had tragic consequences for our economy and our society. The IMF has now got the message. George Osborne remains, to use that dreadful but sometimes useful phrase, "in denial".

■ Five Days in May: The Coalition and Beyond, Andrew Adonis, Biteback Publishing

The shadow chancellor's pledge to match coalition cuts smacks of a failure of nerve. Perhaps Ed Balls should re-read his celebrated Bloomberg speech of 2010

Has the Labour party thrown in the towel? Are rightwing commentators correct in claiming that recent speeches by Ed Miliband and Ed Balls amount to surrender? Given the strength of Balls's compelling case against the coalition's austerity programme – from that prescient Bloomberg lecture in August 2010 onwards – the news that Labour intends to stick to the coalition's spending plans for 2015-16, essentially acquiescing in a policy it had successfully ridiculed, is disturbing, to put it mildly.

That celebrated Bloomberg lecture drew reluctant admiration from no less a Conservative figure than Alexander "Boris" Johnson, who noted that George Osborne's warnings of a Greek-style sovereign debt crisis and cripplingly high interest rates proved wide of the mark. At the time Johnson, taking Balls seriously, expressed fears of a double-dip recession and called for the government to go easy on its austerity programme.

We now seem to be witnessing a collective failure of nerve. At just the moment when even the International Monetary Fund is owning up to having got it wrong, Labour, fearful of entering the next election campaign being pilloried as the spending party, gives the impression of being trapped in the headlights. And just for good measure, those highly respected independent thinktanks, the Institute for Fiscal Studies and the Institute for Government, have lamely accepted that it is going to be a case of "austerity, austerity, austerity" for the remainder of the decade.

One commentator has compared the situation to 1976, when the chancellor, Denis Healey, turned back at Heathrow rather than fly to an IMF meeting in Manila. The IMF people who mattered were closer to home, and there was an almighty crisis. Conservative commentators never tire of quoting the speech by prime minister Jim Callaghan to the Labour conference in the midst of that crisis, when he said that the days of spending one's way out of recession were gone. But, as Callaghan made clear in his memoirs, that speech was entirely tactical.

The fact of the matter is that the only way an economy can emerge from depression is by spending its way out. And if the banking system has, to all intents and purposes, gone absent without leave, and the private sector is in the doldrums, then the public sector has to step in. Month by month, analysts grasp at straws whenever there is an economic indicator suggesting that there could possibly be the beginnings of an upturn. But in the early stages of a traditional economic recovery one should be looking for a sustained growth rate of two, three or four percent, until the huge amount of slack in the economy – idle plant, unused machinery, unemployed people desperate for work – is absorbed.

Yet that most reputable of think-tanks, the National Institute of Economic and Social Research, which recently celebrated its 75th birthday, observes in its May review: "The absence of a sustained period of robust growth has plagued the UK economy since the end of the 'Great Recession' in the second quarter of 2009."

That was the time when, with world trade collapsing at a rate of 20% per annum, G20 policymakers, with Gordon Brown at the helm, steered the world economy back on course, with the aid of a $1 trillion collective stimulus. Brown wanted to maintain the stimulus: the US government did, but the 2010 coalition did not, in the name of budgetary consolidation. The US budget position improved dramatically with economic growth while the British deficit, in the absence of decent growth, continues to be an embarrassment. As Niesr notes about this country: "Economic performance is perhaps better described as 'stagnant'." The coalition is presiding over the worst recovery ever.

In his 2010 speech, Balls rightly said the deficit and level of national debt must be tackled eventually, "but only once growth is fully secured and over a markedly longer period than George Osborne is currently planning".

Growth at this stage is manifestly not fully secured. The coalition is planning drastic cuts for 2015-16 without having the faintest idea whether the economy will have emerged from depression. For Labour to commit itself to acceptance of those cuts at this stage is economically unwise. Some political correspondents may salute the Opposition for heading off Conservative criticism, and listening to ill-informed focus groups, but this is all spin.

As Balls said himself in 2010 of the banking crisis, the country "has been through a once-in-a-generation event like the second world war … it was possible for our postwar government to have the wisdom and foresight to recognise the benefits of a slower, steadier approach to reducing an even bigger debt."

The temptation for an electorate that has heard Labour attack austerity for three years, and now learns about what appears to be a major U-turn, is to ask: so what is the difference between the parties?

Well, there is a difference. It was reported a few weeks ago that Labour had abandoned its plan to cut VAT. What Ed Balls actually said in his speech on 3 June was: "Today, with growth prospects still very uncertain … a temporary VAT cut now is still the right prescription … "

Unfortunately, Labour is not in a position to make a temporary VAT cut. Without a major boost to demand, the situation in 2015-16 could still be one of a barely perceptible recovery from depression – which makes the adoption of plans for further spending cuts look all the more eccentric.

It is not 1940s austerity under a Labour government that Ed Miliband should be invoking but 1950s recovery

'David Cameron genuinely tried to detoxify the Conservative party in the belief that his right wing had nowhere else to go … then along came Ukip." Thus spoke a senior Conservative figure recently, on the eve of Labour's truly amazing U-turn on economic policy in general and austerity in particular.

The speaker was one of many traditional Conservatives who were bemoaning the way their party, still suffering the fallout from rightwing resentment at the defenestration of Margaret Thatcher 23 years ago, seemed to be tearing itself apart. I lost count of the number of Tories who complained that "divided parties do not win elections".

Meanwhile, they noted with reluctant admiration how perceptive from the outlet had been the analysis by shadow chancellor Ed Balls of the weaknesses of George Osborne's economic strategy. They might not like Ed Balls; indeed, the shadow chancellor has a remarkable ability to put Conservatives' backs up; but how right he had been in predicting the failure of a strategy that has been dubbed with the oxymoron "expansionary fiscal contraction".

Before we go any further, it is worth addressing those critics who argue that the austerity policy is not the cause of the crisis. The answer is simple: those, alas all too few, of us who go on about the austerity policy are perfectly aware that the roots of the depression lay, and lie, with the failure of the financial system. The point is that programmes of austerity in the UK and the eurozone have aggravated that crisis and been almost tailormade to prevent a recovery.

Indeed, there is an impressive weight of evidence that recovery had begun in 2010, thanks to the collective impact of fiscal and monetary measures known as "the stimulus", but the recovery was aborted by the premature abandonment of the fiscal side of the stimulus. Indeed, pace the incoming governor of the Bank of England, Mark Carney, there is a limit to what monetary policy can do, as his central banking colleagues around the world are beginning to emphasise – a limit recognised decades ago by John Maynard Keynes, who emphasised the importance of fiscal policy.

Fiscal policy involves changes in the levels of taxation and public spending, in order to stimulate a depressed economy or to cool down one that is overheating. That policymakers may have ignored the "slowing down" side of fiscal policy is no argument against what should be a fitting response to depression, namely fiscal expansion.

The perversity of policies adopted in the UK and eurozone is that, far from going for fiscal expansion, the likes of George Osborne have deliberately opted for contraction.

It is certainly easy to point out that even in this objective they are missing their targets. The point is that they have not opted for conscious expansion. They talk about the importance of growth but do nothing to stimulate it. Indeed, perversely, they do the reverse. Hence, after the sensational fiscal tightening of the coalition years, last week Osborne piled on the pressure with yet more planned cuts.

Yet senior Labour party members, instead of capitalising on their success in attacking the government's failed strategy, choose to hoist the white flag and accept the broad thrust of the chancellor's policy, quibbling over the details, and even then sounding as though they are terrified of saying anything that might upset the rightwing press.

They call this the need for credibility. Do they not see that in the very act of seeking credibility they are losing it?

A veteran of many past Labour efforts at seeking credibility, Roy Hattersley, makes an appeal for sanity in a new book (The Socialist Way – Social Democracy in Contemporary Britain, I B Tauris). Labour has a choice, he says: "It can grub about in search of policies which will attract the swing voters and lose the next general election or it can become again an indisputable party of principle and win."

This economy, with masses of spare industrial and service capacity, and millions who are either officially unemployed or in work but underemployed, is crying out for a serious economic recovery programme. There are hundreds of thousands of houses or flats to be built, and there is a huge opportunity for investment in our public infrastructure – the infrastructure that the most rightwing entrepreneur requires in order to conduct private business.

Labour should be planning tens of billions of spending, in an economy that is running up to 15% below what historical trends indicate is possible. It is not 1940s austerity under a Labour government that Ed Miliband should be evoking but 1950s recovery.

The defence of Labour's U-turn is that "this is all about politics". Yet, as we were reminded by the Treasury's chief economic adviser, Dave Ramsden, last week, in a lecture at the Mile End Group, Queen Mary, University of London, it was because Balls rightly argued that the decision about entering the eurozone should be based on economics, not politics, that Gordon Brown instituted an enquiry based on what were known as "the five tests".

Ramsden was the key civil servant in charge of that exercise, and he made clear in his lecture on the 10th anniversary of the unveiling of the results that the result was not predetermined by Brown or Balls but was a genuine analysis.

Most people think Labour got it right putting the economic case above the political. It saddens me that they seem to be abandoning their economic case about austerity for what they seem to think is a short-term political advantage – which to my mind sounds dubious anyway.

Good weather has encouraged the rightwing press to forecast recovery, but we still haven't got back to 2008 conditions

Many years ago I spotted a correlation (a favourite word among economists) between a certain financial commentator's daily pronouncements on the state of the economy and the weather. When it was sunny, the news was always being interpreted as being good; when it was miserable there appeared to be a sudden downturn in the economic outlook.

This came back to me during the recent spell of hot weather: there seems to have been an outburst of optimism about the economy, especially in the rightwing press. It has all been worth it, we are told by the Treasury: the economy is moving "from rescue to recovery". Even the International Monetary Fund is revising its UK forecasts upwards, and the newspapers hint that the IMF chief economist Olivier Blanchard was quite wrong a few months ago to call for a British "Plan B".

Now, it was Samuel Beckett who is supposed to have said when asked by a friend if good weather made him glad to be alive: "I wouldn't go as far as that." As one who is glad to be alive in fair weather and foul, I have to say that I would still not risk betting on a sustained recovery and I should never accept the idea that it has all been worth it. It is, for example, stretching several points for the chancellor to claim that he has "rescued" the economy when for several years now he has been giving it the 19th century leeching treatment.

The message from monthly and quarterly statistics and regular surveys of business opinion can be interpreted in many ways. For instance, economists, especially Americans, like to "annualise" new figures: if one does that to the latest estimate from the National Institute of Economic and Social Research it is, in theory, time, if not for rejoicing, then certainly for breathing a massive sigh of relief.

Thus the NIESR estimates that in the April-June quarter gross domestic product grew by 0.6%, equivalent to an annual rate of about 2.5%. If this could be sustained, then one could begin to talk seriously of a recovery, although, by past standards it would hardly be sensational. During a typical recovery in previous decades the British economy would grow for a time at 3-4% per annum, before settling down to the long-run average of close to 2.5%. (Figures in real terms, after taking account of inflation.)

The NIESR's reasonable definition of recession is "a period when output is falling or receding". At the moment it looks as though the recession is over, although, with the banking system still so fragile, and the eurozone far from out of the woods, all hell could yet break loose. But, even on the assumption that all hell does not break loose, and there is a sluggish recovery from now on, the chances of even the 2.5% annualised pace of April-June being maintained are very slim, and outside the sights of most forecasters. As Ed Balls has pointed out, the revised IMF forecast for the UK this year, at 0.9% growth year-on-year (against 0.7% forecast in April) is still below the 1% it expected at the turn of the year.

The growth in the second quarter was largely in services, with manufacturing output, on which we depend for almost two-thirds of our export earnings, actually running lower than a year ago. The NIESR uses the term "depression" to describe a situation where GDP is below its previous peak; it expects, on current trends, that the peak reached in 2008 will not be regained, at the earliest, until 2015.

Of course 2015 will be an election year. The chancellor can be confidently expected to claim that he has worked wonders when all that will have been achieved is a return to the position two years before he took office.

It is a lamentable record: the worst recovery ever, under a chancellor who talks about growth and enterprise, and under policies which are causing unnecessary hardship to many of the poorest in our nation.

Of course, this depression is taking place at a much higher level of general living standards than in the terrible depression of the early 1930s. And to look around central London, parts of which give the impression that the population is engaged in one perpetual street party, you could be forgiven for thinking that critics such as myself are making it up.

But we are not. The cuts are at their most savage in the way that local authorities are being forced by central government to cut back on essential services, and not least in the way that years of neglect, by both major parties, are showing up in the housing crisis. This government's bedroom tax is arguably "the unkindest cut of all".

The government is also culpable for its sluggishness in recognising the opportunity provided by low long-term interest rates for a major infrastructure programme. We are three years into this coalition and it is only just waking up to the infrastructure crisis, having meanwhile aggravated it with savage cuts in investment.

Our cheeky chancellor rationalises the position by claiming that he has "created the space" for infrastructure spending. But as the economist John Llewellyn points out: "If we had had the infrastructure spending, the space would not be there."

Do not be fooled. There may or may not be a modest economic recovery from now on, but the strategy of fiscal retrenchment to make space for a private sector recovery has been a lamentable failure, at considerable, and needless, social cost.

The Aussie strategist has forced the Labour leader into an assault on the unions just at the moment when low pay is becoming a crucial issue

The beginnings of the long-awaited British economic recovery, insofar as they are soundly based, are of course to be welcomed. But insofar as the recovery depends on old-fashioned inflation of house prices, one should beware.

The idea, however, that the good figures for gross domestic product in the second quarter constitute a justification of the coalition's leeching approach to the economy is laughable, indeed contemptible.

Moreover, it is not strictly accurate that we are now witnessing the beginnings of recovery from the financial crisis of 2007-09. For the economy was recovering under the much-derided policies of Gordon Brown and Alistair Darling in 2009-10 until it was hit on the head by the coalition's decision, egged on by a misjudgment by the Bank of England, to unveil an entirely unnecessary policy of austerity.

We have now had three years of George Osborne's cynical attempt to manipulate the electoral and economic cycle. What this nation and leading industrial economy has been subjected to is not so much a deficit reduction strategy as a growth reduction strategy, accompanied, ironically, by precious little progress in deficit reduction.

By contrast, although the recovery in the US has been constrained in recent months by the impact of the Republican-induced "sequestration" cuts in public spending, the growth-orientated policy pursued there has been a laboratory experiment in the relationship between growth and deficit reduction.

It can hardly be emphasised enough how right the shadow chancellor Ed Balls was in his Bloomberg speech of August 2010 to oppose the Osborne plan. His predictions of the consequences were all too accurate. Also, let it be stressed, those of us who agreed with Balls and have opposed the economics of austerity and lost growth took no pleasure from seeing these predictions fulfilled. It was therefore with a heavy heart that one witnessed Labour's recent U-turn on cuts, with its promise to adhere to the coalition's spending plans for 2015-16 – if Labour returns to power, that is.

Which brings us to the extraordinary turn of events in recent months, during which the Conservatives in general and their strategist Lynton Crosby in particular, seem to have so unnerved the Labour leadership that many are beginning to wonder whether Labour is in danger of seizing defeat from the jaws of electoral victory.

A local episode concerning the trade unions and the Falkirk Labour party appears to have turned into a full-frontal assault by Labour leader Ed Miliband on the trade union movement, at just the time when concerns about low pay and inequality are emerging not only as a social issue but also as one that has macroeconomic relevance. The macroeconomic point is that more and more research indicates that the pace of economic growth is being affected by a squeeze on real wages – quite apart from the Europe-wide outburst of austerity economics.

As the veteran political journalist Ian Aitken observed last week: "There is a link between low pay and the need for unions." And it is refreshing to note that an alliance between Balls and the US economist Lawrence Summers is looking at ways by which the fruits of economic growth can be more fairly shared than in recent decades.

Aitken, a great Tribune columnist these days, worries, only half-jokingly, that, by having Miliband on the run over Labour's historical association with the unions, Crosby is running Labour policy as well as Conservative. Crosby is the most successful spinner the Australians currently have in the country.

One just hopes that Miliband gets himself off the hook whereby he risks Labour divisions over the unions taking over from Conservative divisions over Europe as the key factor in the runup to the next election.

There is still a long way to go. As Lord Adonis, Labour's secret weapon, pointed out last week at the Mile End Group's launch of his book Five Days in May on the 2010 coalition negotiations, at the last minute of those negotiations the future chancellor George Osborne swung opinion in favour of a five-year term.

We are, God help us, only just over halfway through this parliament. Adonis, who is a doer as well as a theorist, is working hard on Labour's growth strategy for the next election. Let us hope he helps to pull the opposition together after this moment of weakness.

Meanwhile, behind all the fuss about one quarter's revival, let us note that output remains some 15% below what historical trends would have pointed to. The coalition has undoubtedly won the prize for the most successful growth reduction strategy in living memory.

A leading British academic concludes that the last government has been tarnished by spin, while the US treasury secretary follows Gordon Brown's lead

The most dangerous chancellor of my career, one George Osborne – Jeffrey to President Obama – tells us the economy is "on the mend". I, too, am on the mend. The difference is that the fracture to my shoulder was the result of an accident, whereas the austerity policy was no accident, but deliberately inflicted on an economy that had been gently recovering from the financial crisis.

I repeat, from the financial crisis, not a fiscal crisis. The coalition, egged on, alas, by the Bank of England, made two egregious errors of judgment in 2010. In the chancellor's case, these errors were encouraged by a cynical political calculation related to the electoral timetable. In the Bank of England's case, quite apart from its errors of judgment about the nature of the crisis, there was the additional question of whether a body that had been granted independence in monetary policy should have been interfering in fiscal policy.

The first error was to compare the British economic situation to that of Greece. I have found during my travels that even lay people who had no idea of the strength of the British position as an international borrower – an average maturity on our national debt of 14 years, not 14 weeks – found comparisons to Greece risible. The second error was to accept the view that, before the onset of the financial crisis, the British fiscal position was out of control.

It has to be conceded, however, that the coalition's judgment that it could fool a lot of the people a lot of the time with this blatant misrepresentation was all too shrewd.

In which context I strongly recommend the spring issue of the Oxford Review of Economic Policy. It covers the economic record of the 1997-2010 Labour government in considerable and balanced detail, warts and all. The chapter of particular relevance to the austerity policy is the one by the economist Simon Wren-Lewis, who is widely respected in the profession, and who played a notable role in the famous "five tests" study published in 2003 – which ended in the conclusion that Britain should not join the eurozone. Wren-Lewis finds that fiscal policy (taxation and spending) was actually too tight in the early years of that administration, overcompensated in the middle period, and failed to correct sufficiently in the final years.

But in the face of the great recession, the supposed benefits of tighter policy in the latter years would have been small: "The debt-to-GDP ratio in 2007 was lower than its level in 1997, and the net borrowing requirement was fairly close to a neutral 2% deficit, so it cannot be said that fiscal policy was seriously deficient over this period."

Wren-Lewis concludes that, with the onset of the recession, "the Labour government had two key fiscal decisions to make: by how much, and by what means, to try and stimulate the economy … and how quickly to plan to correct the deficit caused by the recession and any countercyclical action it took … my own view is that the government was absolutely right to try to use fiscal policy to mitigate the impact of the recession, and it was also right to plan to correct the deficit relatively slowly."

This rigorous academic observes that is it is unfortunate, but hardly surprising, that the Labour record of this time has become highly politicised. "The line that the Labour government was responsible for leaving a disastrous fiscal position which requires great national sacrifice to put right is pure spin," he says.

Unfortunately, it was not just the British government that made the wrong diagnosis and chose the wrong policy after the crisis. Alas, most of continental Europe chose, or in many cases was forced, to go down the blind alley of austerity.

Jack Lew, the relatively new US treasury secretary, wrote recently in the Financial Times: "While long-term fiscal policy requires tough decisions, we knew we could not cut our way to prosperity."

This highlights the difference between the UK/eurozone approach and that of the US. Again, as Lew says: "To remain on the path of continued growth, we need to avoid self-inflicted wounds while we are still trying to make up lost ground."

Lew has now taken up the baton from Gordon Brown when it comes to politicians who understand the nature of the huge deficiency of demand in the world economy. People go on about the need for supply-side policies, but the fact is that there is no shortage of supply, but of demand, which continues to be constrained by the vogue for totally unnecessary and hugely destructive policies of austerity.

The wonderful summer weather has lifted the spirits, and there have been minor improvements in economic performance and the outlook for both the UK and the eurozone.

But we cannot rely indefinitely on Mario Draghi (the president of the European Central Bank) and his promise to do "whatever it takes" to save the situation … The crucial part of Draghi's statement that people ignored was the second half: "within our mandate". The ECB's mandate is far too deflationary. The irony is that, outside the eurozone, we are not bound by that mandate. What we have been bound by is the misjudgment of our policymakers.

Within the straitjacket given him by George Osborne, the new governor of the Bank of England is reduced to giving guidance

This is the time of year when my Treasury friends are likely to say, with just a hint of menace, "Enjoy the exchange rate you have so long advocated." This, of course, is a reference to the way continental holidays have become a lot more expensive than they were, thanks to the devaluation of the pound that was a necessary condition of restoring British industry's price competitiveness after a long period, under the Conservatives and Labour, of overvaluation.

Traditionally the Bank of England does not believe in devaluation, or at least in advocating such a policy in public. Lord King, who was governor from July 2003 to June this year, made no secret later on in his term that the devaluation was a necessary condition of his plan to "rebalance" the British economy.

Whether our economy is rebalancing towards a healthier overseas trading position is an open question. Chancellor Osborne seems of late, in the face of the demise of his eccentric, damaging and oxymoronic policy of "expansionary fiscal contraction" to be relying partly on an old-fashioned boom in house prices– the sort of development that contributed to the financial crisis in the first place.

Oh, sorry, I nearly forgot: the chancellor is also relying on the putatively magical powers of Mark Carney, Lord King's successor, who is rapidly acquiring the kind of showbiz reputation we have not seen in central banking since Che Guevara was governor of the central bank of Cuba.

We have yet to see how successful Carney will be in the role of revolutionary. His paper on forward guidance for the financial and other markets in monetary policy, published last week, is supposed to give key decision-makers in industry and finance some assurance about the prospects for interest rates when they're making their investment decisions, and make decisions about mortgages easier.

His main message was that the financial markets had got ahead of themselves in expecting any tightening of monetary policy in the foreseeable future. A recovery may be under way, but it is weak by historical standards, and there is still a significant margin of spare capacity.

That shrewd fellow Canadian student of politics, Professor Colin Campbell, spotted early on that Carney hails from the central casting school of central banking, whose de facto head is Ben Bernanke, chairman of the US Federal Reserve. They are both "growth men", with a desire not to slow down an economic revival until unemployment falls to a certain level.

As recent panics in the financial markets have demonstrated, however, the guidance of markets is more easily promised than achieved. Anyone who listened to what Bernanke was saying last month should have got the message that he was worried about the negative impact on the US recovery of the Republican-induced "sequestration" budget cuts.

Carney, who uses phrases such as the need for "escape velocity" is, for all the hype, up against the limits of monetary policy in time of depression, with the added problems of his political mentor's austerity policy. Did I say depression? According to some reports, it is now "boom, boom Britain", although output is still below 2007 levels. We shall see.

At all events, Carney is reduced to what the Americans call "jawboning" – a talent he put to good effect at his first inflation report press conference last Wednesday. He followed that session with some further jawboning to selected City and other leading economists at a separate lunchtime session.

He has certainly made a splash so far. Indeed, one can hardly get away from news about him. Why, the other weekend I was lunching with the economist Simon Broadbent in the garden of his house in Dorchester-on-Thames, and asked about the history of Dorchester abbey, which adjoins the Broadbents' garden. "Before we get on to that," he said, "you may or not like to know that that is where Mark Carney got married."

We now await evidence of his divine, or divining, powers. We learn that, among other things, the Treasury wants him to shake up the Bank. Tell me something new. When I was editor of the economic section of the Bank of England bulletin in the mid-1970s the new governor Gordon Richardson and chief economist Christopher Dow were trying to shake up the Bank. (By the way, when I returned to journalism, Broadbent succeeded me. We recalled the other day that in our time there was lots of inflation, but no monthly inflation report.)

One gathers that there is quite a lot of shaking going on in Threadneedle Street – a lot more than the high-profile resignations of people like my friend Paul Tucker.

Certainly, Osborne is relying heavily on Carney, having given him a financial salary "package" that thoroughly upset many, and not just at the Bank. Carney spent a lot of time refusing Osborne's overtures. His refusals were "right at the time". David Marsh, chairman of the OMFIF (Official Monetary and Financial Institutions Forum), has a nice theory that Carney's final wage demand was made on the assumption that Austerity Osborne would have no choice but to turn down such a ridiculous request.

This said, I am encouraged by the emphasis Carney is putting on the need to reduce unemployment, which is still a million higher than when the financial crisis struck. The new player at the Bank of England may, in due course, justify his transfer fee.

The chancellor pursued his star central banker as it became clear that 'expansionary fiscal contraction' had failed. Any revival is happening despite austerity, not because of it

After a Carney-free fortnight in Asia Minor, I returned to Blighty to find even my dentist singing the praises of the new governor. Having temporarily abandoned his ambition to be prime minister of Canada or head of the IMF – at 48, he has time on his side – Carney has in effect accepted the role of frontman for George Osborne's election campaign.

The governor enjoys the limelight, and turned down an invitation to share a stage with the chancellor and other dignitaries at the Institute of Directors' annual conference in favour of his recent solo media event in Nottingham, where he seems to have impressed television viewers such as my dentist with smart answers to questions about the prospect for exchange rates: some would go up; some would go down.

A famous spin doctor who spoke to me on condition of anonymity suspects that Carney is riding for a fall. We shall see. He is certainly trying to be the George Clooney of central banking, and ought to have sufficient grasp of history to beware of fostering his own personality cult.

The dangers of disregarding history are vividly explained in a new book When the Money Runs Out by Stephen D King, the group chief economist at HSBC. King castigates his fellow economists for choosing, in their obsession with "precision-engineered mathematical models", not to recognise "the myriad economic failures that have occurred throughout the ages, believing that those past failures had no relevance to the modern world".

Yet here we are, having experienced the worst economic depression and slowest "recovery" of several lifetimes, and we have a government that talks about "rebalancing" the economy – towards more physical investment and a solid capacity for exports – but in fact is doing its best to stoke up an old-fashioned consumer and house price boom, of the sort that history tells us is almost bound to end in tears.

Osborne's gamble, of course, is that the tears will not be shed until after an election victory. Meanwhile, he hopes to fool most of the people until that time with the illogical and wholly unjustified claim that the cynical policy of austerity has been worthwhile, because it has "laid the foundations" for recovery.

In fact, Osborne's policy has been shaking the foundations rather than laying them. And to judge from Carney's public utterances and his written evidence to the House of Commons Treasury committee, he has made a serious study of recent British economic history and understands the trading problem, which was exacerbated by years of overvaluation of the pound, until the post-2007 devaluation.

It is worth recalling the background to Carney's appointment. The chancellor sought him out, and pursued him like a love-struck bobbysoxer, because he knew that his own economic strategy had failed.

"Expansionary fiscal contraction" proved to be the oxymoron it always seemed to be: while investment in infrastructure was cut, and the poor suffered disproportionately from the savage squeeze on social services and local authority expenditure, the private sector did not fill the gap.

Osborne's belief was that a spontaneous revival of the private sector would fill that void, encouraged by loose monetary policy. But real incomes were reduced both by the ill-advised increase in VAT in 2010 and by the way that strong demand in China and other so-called "emerging" economies kept oil and other commodity prices high.

Economic history teaches us that there comes a time when, even in the face of crass macroeconomic policies, economies will eventually hit bottom and begin to revive. That this is happening at last is obviously to be welcomed, although the emphasis the government is putting on boosting demand for existing houses, as opposed to the massive housebuilding programme advocated by Labour, is disturbing, and even caused the outgoing governor, Lord King – who had been all too supportive of the fiscal squeeze – to register his concern about what the government was up to.

Carney seems too relaxed about the dangers of the house-price bubble, which is being encouraged by the government and his own promise of low interest rates for the indefinite future. That shrewd observer Trevor Greetham, of Fidelity Worldwide Investments, warns: "The government has lost patience with talk of living within one's means. With the 2015 general election coming into view it has unleashed the beast, tempting consumers to leverage their balance sheets into a new housing bubble."

Nevertheless, any signs of a more broad-based recovery are to be welcomed, as long as people are not fooled into thinking this is the result of misconceived and wasteful policies of austerity. It remains to be seen how widespread this incipient revival will prove, and how sustainable.

It was that great Bank of England chief economist, Christopher Dow, who used to say, before the summer holidays, "things will look very different in September".

They do – for the moment …

The chancellor, with characteristic hyperbole, is trying to take the credit for the nascent economic upturn. His Bank governor seems less convinced

The choice of the person to govern a central bank is one politicians and financial markets take very seriously. Chancellor George Osborne devoted a fair proportion of 2012 to the pursuit of his ideal candidate, and eventually persuaded the Canadian Mark Carney to accept the governorship of the Bank of England.

Although there was a formal interview process, there was little doubt who was going to get the job. A key factor in these matters is that candidates should not have too many enemies. Nobody in high places wanted to veto Carney, whereas in the past the road to the governor's parlours has been littered with the bodies of outstanding candidates who incurred black marks.

The big international news in these matters last week was that Lawrence Summers, President Obama's favoured candidate to succeed Ben Bernanke as chairman of the US Federal Reserve, withdrew from the race because it had become clear that he had too many enemies on Capitol Hill, and the confirmation (or not) process threatened to become an embarrassment.

Although people speak very highly of others in the running, such as Bernanke's deputy, Janet Yellen, it is nevertheless sad that someone of Summers's outstanding ability and experience – he is a formidable economist, was treasury secretary under Bill Clinton and, more recently, a key economic adviser to Obama – should have felt it necessary to withdraw his candidacy for the most important central banking job in the world.

One objection was his championship of deregulation in the 1990s. But he was not the only one: there was an international consensus in favour of such moves at the time, and Summers has undoubtedly learned from experience.

The consequences of deregulation and blind faith in the all-too-invisible benefits of financial engineering have been with us since 2007 and the onset of the financial crisis – which did not, as some appear to believe, begin with the collapse of Lehman Brothers in September 2008, but was most certainly aggravated by that fiasco. But Summers learned the hard way, and was a powerful force for good in Obama's White House when it came to rescuing the system, in the face of Neanderthals who opposed the worldwide fiscal and monetary stimulus of 2008-09 and the rescue of the banks.

Summers's US critics were evidently worried he would be "too hawkish". Clearly, they were not acquainted with, or chose to ignore, the impressive series of articles he has written over the past few years for the Financial Times, one consistent theme being the dangers of withdrawing the stimulus when sustained economic recovery is far from assured, as Bernanke re-emphasised last week.

Which brings us back to the UK and the debate about economic recovery here. The chancellor – endorsed, laughably, by deputy prime minister Nick Clegg – maintains that the recovery we are experiencing is the result of his policies of austerity and indeed caused by them. (I'm not making this up.)

To the chancellor, critics of his policy have been proved wrong, simply because there are the beginnings of a recovery. The emphasis, by the way, must still be on "the beginnings", because with average incomes barely rising, and at a rate markedly below the rate of inflation, it is difficult to see how a broadly based recovery can be sustained. Hence the chancellor's stoking-up of a housing bubble, with all the familiar dangers that entails.

With characteristic hyperbole, Osborne maintains that his critics argued that, in the face of his austerity policy, there could be no recovery. It would be more accurate to say that what we were all concerned about was the way the fiscal squeeze was inhibiting the chances of recovery, and that an awful lot of output was being lost meanwhile, and an awful lot of unnecessary damage inflicted, especially on the most vulnerable members of society. (See your local newspaper passim.)

Output in the UK is still some 3% below its level in 2007-08, and some 17% below what might have been expected from historical trends. Just think of all the business investment opportunities that have been missed!

Now, the effect of the banking crisis on the availability of credit had a major impact, as did attempts by businesses and individuals to cut back – "deleveraging", as it is known in the trade. And, no, we were not helped by the depressed condition of our important markets in the eurozone.

But these were all reasons for the government to counteract the impact of the depression by continuing with the stimulus it inherited from Labour, instead of raising VAT and inflicting harmful and unnecessary cuts.

When, amid all the razzmatazz surrounding Carney's arrival at the Bank in August, he held his first press conference, your correspondent asked him to what extent the fiscal squeeze was counteracting the Bank's attempts to encourage recovery.

With great aplomb, the new governor ducked the question and answered a completely different one. But during his recent testimony to the Treasury select committee, Carney made a very important statement, and went way off message as far as his patron Osborne was concerned.

"The fiscal adjustment," said the governor, "has been a drag on growth." I shall repeat that: the fiscal adjustment has been a drag on growth – not, as the chancellor would have it, the cause of the recovery.

The chancellor's obsession with playing Scrooge with public finances can only be bad news for the poor and disadvantaged

During his historic speech to the Conservative party conference in Manchester last week, chancellor George Osborne stressed several times that, notwithstanding his plan to pursue policies of austerity until the end of the decade, he was at heart an optimist.

This reminded me of the time my late father motioned to my brother Victor and me one day and said: "Hey, lads, do you want to know the definition of an optimist? Well, I am 85 and I have just bought myself a new suit."

Father lived on another seven years, to the ripe old age of 92. Osborne appears to be planning another seven years of chancellorial (and, possibly, prime ministerial) life, which is indicative of the kind of arrogance that goes well with his cheeky-chappie image.

We have a chancellor who combines "responsible" fiscal policy with an apparent desire to be responsible for a lot more spending cuts that will be directed largely at the poor and defenceless.

What interested this observer was that, whereas a Labour conference that had gone down well with the public clearly had the Conservatives on the run – hence Osborne's populist freezing of fuel duty, and one or two other measures – the chancellor was absolutely shameless in the way he laid on the propaganda that what this country needs is even more austerity.

By austerity in this context I mean his seven-year plan to achieve "absolute" budget surpluses by further dramatic cuts in public services in general and so-called "welfare" in particular – the old term social security is a better one for what governments began to do after the second world war in order to eliminate the fear, for jobs and lifetime security, that afflicted so many of the prewar generation.

While in Manchester I popped into the city's art gallery and saw Holman Hunt's famous picture The Scapegoat. It was an appropriate symbol of one of the chancellor's monotonous themes – that the deficit he inherited was caused by the Labour government's profligacy.

The vast bulk of the deficit was caused by the impact of the banking crisis in precipitating the recent depression. It was not so much public spending that caused the rise in the budget deficit in Labour's latter years as the steep decline in tax revenue when the calamity hit the British and world economies in the final quarter of 2008. Moreover, I seem to recall that at the time Messrs Cameron and Osborne fully backed Labour's spending levels and were planning to stick with them!

It has been interesting to see how rattled both the Conservative party and the Daily Mail were by the success of Labour's conference the previous week. Where Ed Miliband has found a chink in the Conservatives' armour is their vulnerability to charges that they are insensitive to public concern about the abuses of modern capitalism.

This is the link with the public's concerns about the cost of living: too many of the fruits of economic growth, such as it is, have been accruing to the fat cats. And, not to put too fine a point on it, people feel exploited by the modern equivalent of the US robber barons of the 19th and early 20th centuries.

It was a feature of the development of American capitalism – no socialists among the practitioners over there! – that monopolistic and oligopolistic practices should be legislated against: "trust busting", as it was known. Modern socialists are well aware that capitalism triumphed over the alternative. With the acceptance of the mixed economy, both the left and the right have vied for the power to watch over modern capitalism. Unfortunately, but predictably, things got out of hand after the collapse of the Soviet Union, with results that brought us the financial crash.

Socialism has come to mean running a mixed (public and private sector) economy in the interests of society as a whole, not least the weak and defenceless. Which brings me to why I may have surprised some readers by describing Osborne's conference speech as historic.

I refer to the chancellor's complaint that there have been only seven years when the budget has been in absolute surplus in the last 50 years, and his aim to work towards an absolute surplus over the next seven years – ie, a surplus on the current and capital account combined.

Capital expenditure is long term: most economists believe this should be funded by long-term borrowing, and that it makes sense to separate this in the public accounts. As the chancellor almost boasts, the implication of his declared strategy is to be even more ruthless with his attack on current spending in general and social welfare in particular.

As I watched our smooth-talking prime minister and chancellor go on about "welfare" I thought it was time for them to reread Dickens's A Christmas Carol. Like modern Scrooges, they should be escorted by members of the Child Poverty Action Group and other charities on a rather different social round to what they are used to – ie, to see at first hand the hardship they are aggravating with their austerity policies.

The showdown in Congress reveals how ill-prepared many American legislators are to deal with a global economic crisis

It is an ill wind that blows nobody any good. In 2007 the International Monetary Fund was facing a financial crisis of its own. The IMF makes money by borrowing and lending, taking a "turn". In 2007 it was short of customers. Then along came the world financial crisis, and the fund was back in business. Alternative plans for financing itself were shelved.

The recent annual meeting of the IMF in Washington was overshadowed by the threat of another famous organisation facing an operational crisis – no less an entity that the one responsible for overseeing the most powerful economy in the world, namely the government of the United States of America. The shenanigans over the partial shutdown of US government activities, which began some weeks earlier – and the threat of escalation when the legislative ceiling on what the US could borrow was reached – have made a laughing stock of a constitutional system that sees one of its missions to bring democracy to the Middle East and elsewhere.

James Madison, a revered "founding father" of the US constitution, was anxious that minorities should not be tyrannised by majorities. In recent years it has been the remarkable achievement of the extreme rightwing faction of the Republican party to ensure that a minority – the Tea Party – has tyrannised the majority: not only the majority of the Republican party itself, but also the majority of the US electorate, to say nothing of the majority of the rest of the world, given the potential ramifications of a default by the US on its financial obligations.

It got to the stage last weekend when one seasoned observer of the congressional scene said: "In any other country such an impasse would be resolved by the dissolution of the government and a general election. But not here." Under the constitution as it has evolved, the "system" is one of too many checks and not enough balances.

Things have reached a pretty pass when one finds the Chinese regime telling Washington to get its act together. And it took a sensational plunge in the Republican party's ratings in the opinion polls for it finally to come to its senses.

Apart from anything else, as Lawrence Summers pointed out in the Washington Post, the deadlock diverted attention from the need for a fundamental change of economic strategy. "If even half the energy that has been devoted over the past five years to 'budget deals' were devoted instead to 'growth strategies', we could enjoy sounder government finances and a restoration of the power of the American example," wrote Summers.

For all the fuss about the putative "crisis" of the US deficit, the congressional budget office's forecast is that the deficit will fall to 2% of GDP by 2015. By comparison with the UK and eurozone, the US economy has recovered relatively well from the 2008-09 low point – averaging real growth of 2% a year. Its recovery could have been a lot faster, but there has been a conflict between monetary policy (interest rates and quantitative easing) and fiscal policy (taxation and public spending).

Nearly all the public comment is focused on the Federal Reserve, with its brief to aim for low inflation and maximum employment. Yet there is a limit to what is achievable when fiscal policy is working forcibly in the opposite direction. Federal Reserve estimates suggest that, if it were not for the fiscal squeeze, the US economy might reasonably be expected to have grown by 3.5% per cent this year, not 2%, although the recent disruption to government service might have tempered that somewhat.

The point about fiscal policy is that there is a big difference between what's inappropriate in the short term, during recession or emergence from recession, and longer-term issues associated with, for example, an ageing population and the associated implications for the cost of healthcare.

In this context it has been quite remarkable how poor the financial markets have been in judging the prospects for the Fed's actions with regard to cutting back the monetary stimulus. The retiring chairman, Ben Bernanke, has been commendably consistent in pointing out that, while in the long term interest rates will be encouraged to return to normal levels, in the short term unemployment remains significantly higher than before the onset of the financial crisis.

It was pretty obvious from Bernanke's remarks over the summer that a "tightening" of monetary policy would be premature. This impression ought to have been strengthened by concerns about the behaviour of the Republicans in recent months.

There was a certain historical echo in the way that 17 October was the "make or break" day for the debt ceiling. It was on the same day 40 years ago, in 1973, that the Middle East oil producers announced production cuts and oil price increases in the wake of the Yom Kippur war – the "oil shock" that led to a quintupling of the price of crude and the first major recession since the second world war.

Policymakers eventually adapted to the world of dearer energy. In 2009-10 their successors, with the much-maligned Gordon Brown playing a major leadership role, "saved the world". But there are few signs that the present crop of policymakers have understood there is a time and a place for budget-cutting, and that is not when the recovery is still fragile.

The launch of a new – and factual – report on the EU reminds us how slippery truth has become in the economic debate

The late senator Daniel Patrick Moynihan once told an opponent: "Everyone is entitled to his own opinion, but not to his own facts." This astute comment came to mind when that great pro-European Peter Sutherland – he who, among other things, licked the World Trade Organisation into shape – made a nice observation at the recent launch of The UK & Europe: Costs, Benefits, Options, under the auspices of Regent's University, London.

Sutherland recalled an exchange with a Eurosceptic – or "Euroseptic", as Sir Edward Heath would have said – in which his interlocutor accused him of being "biased towards facts".

Subtitled The Regent's Report 2013, the 237-page document is going to be useful to all sides if we do have to go through what I myself regard as an unnecessary and time-wasting referendum on our membership of the European Union.

For a group of authors who are largely pro-European – and some, even now, pro-eurozone – they have produced a remarkably balanced document, with the emphasis on – wait for it – facts. There is plenty of acknowledgement of the tiresome aspects of the EU, and among a plethora of statistics, some obvious ones stand out.

These will not be new to students of the EU, but you can be sure they will not be highlighted by the anti-Europe brigade – many of whom have very nice houses in France, Spain, Italy and other parts of the EU. Suffice it to repeat here that, for all the fuss made by the anti-European press and Ukip, the entire "Brussels budget" amounts to 1% of EU gross domestic product.

Confusion can be worse confounded when it comes to facts. With economic statistics, we are often talking about estimates rather than facts. I have never found any evidence that Keynes made the remark often attributed to him: "When the facts change, I change my mind. What do you do, sir?"

The explanation is simple: Keynes was far too intelligent to believe that facts could change. Facts are facts. Circumstances can change, and new information or more refined calculation can alter previous estimates.

Which brings us to the present position, and what one has to admire as the superb propaganda of the chancellor. According to George Osborne's interpretation of events, the recent crisis was caused by the profligacy of the Brown government, as was the putative need for austerity. And, hey presto, thanks to his brave programme of austerity, focused to a considerable extent on short-sighted cuts in public sector investment and mean-minded attacks on welfare, austerity has produced "recovery" and growth.

On the subject of mean-minded attacks on the poor, my old friend Sir John Major is to be congratulated for his recent observation that too many vulnerable citizens face a choice this winter as to whether to eat or heat.

Far too many people have swallowed Osborne's line, failing to appreciate that, with the obvious exception of Greece, the crisis was caused by the banks and other financial institutions, not public spending. It was the financial crisis that caused the bulk of the increase in the public sector debt. Moreover, a recovery was under way three years ago, until Osborne took measures to abort it.

Now, within a matter of months, some commentators have moved from talking up a recovery that wasn't there to worrying about the pace of the recent upturn, with GDP estimated to have expanded at an annual rate of 3.3% in the third quarter (in real terms). But, as Russell Jones points out in the latest bulletin from Llewellyn Consulting, "issues of the balance and sustainability of [UK] growth remain".

Investment and construction generally are way below their pre-crisis levels, the emphasis being on an old-fashioned consumer boom, but one that is being fuelled not by real incomes – which are depressed – but by cheap credit and consumer decisions that rely on the persistence of unusually low interest rates.

The biggest scandal of all is that policy is concentrating on encouraging a boom not in housebuilding, but in house prices. Like the Bourbons, the coalition and the Bank of England have learned nothing and forgotten nothing.

The Bank of England? In his early days the new governor, Mark Carney, talked about the need for "escape velocity" in the economy. His innovation was "forward guidance", which was supposed to reassure people that interest rates would remain low for a very long time. But already his chief economist is talking about moving to more "normal" levels of interest rates – which will be a blow to many – and speculating about the end of forward guidance when it has hardly begun.

However, the real coup for the Bourbon strategy is Carney's quite remarkably complacent attitude towards the future of the City of London. He seems to see a future in which a still largely unreformed banking system gets bigger and bigger, with even more of the leverage that made such a marked contribution to the financial crisis. True, he believes there can be reform. I wonder.

This is a dangerous game. Meanwhile, though Labour worries that Osborne may get away with his pre-election boom, the chancellor may be hoist by his own petard. It was Osborne who insisted on a five-year term. I have a feeling that by the summer of 2015 his cynical and reckless policy will have blown up in his face, and be seen for what it has always been.

The Bank governor is playing it by ear, believing there is slack in the economy – and the eurozone could still spoil things

''Unbalanced growth is better than no growth." This was not exactly what the Bank of England's governor Mark Carney said last week when delivering the Bank's quarterly inflation report. It was said by one of his illustrious predecessors, Eddie George, in a previous era. But that was Carney's hidden message, combined with a public expression of hope that growth in the British economy would indeed become more balanced.

The Bank is now confident enough to declare that a recovery is at last under way, but, for all the loud headlines about the timing of rises in interest rates, the true position of Bank officials is that they really do not know how sustainable this recovery will turn out to be.

The "forward guidance" initiated by Carney is that, provided inflation remains under control, there will be no need even to consider raising interest rates until unemployment, now calculated at 7.6% of the labour force, falls to 7%. Even then, the new governor goes out of his way to suggest that, for him, this would not necessarily mark a turning point.

He could hardly have been clearer at his press conference, although to listen to some commentators, you would think differently. He went out of his way to emphasise that there is "a substantial degree of slack" in the economy. What the Bank is really doing is seeing how it goes.

During the recovery phase after most postwar recessions, a growth rate of 3% to 4% was not unusual. This has been a recession – indeed, depression – to beat all previous postwar episodes, and output is still 2.5% below what it was in 2008, and some 17% below what it might have been by now if the historical trend had continued.

The economy appears, from recent data and surveys, to be growing at 2% a year. Unemployment is still far too high, and only time will tell how much spare industrial capacity there is to draw on. Although they don't know exactly how much capacity there is, Carney's use of the word "substantial" suggests to me that he may be nearer to the economic consultant Bill Martin's side of the debate – he calculates that there is plenty – than to the Office for Budget Responsibility, which is more dubious.

This matters because traditionally it is when the economy is operating at full capacity that inflationary tendencies manifest themselves – and, traditionally, the British economy is very good at manifesting inflationary tendencies.

While we are on the subject, I could not resist a wry smile last week when, amid all the concern about energy prices, the Office for National Statistics stated that one of the reasons for the "better than expected" monthly inflation figure was – wait for it – a fall in energy prices. I am not making this up.

But back to that unbalanced recovery. So far the driving force of rising consumer confidence and spending has been assisted by a resumption of borrowing and drawing on savings.

The Bank sees the recovery from now on becoming more balanced, with consumers spending out of income, and businesses investing more. Also it thinks the threat to our exports from the battered eurozone is less than it was. I wonder about this. My hunch is that the troubles of the eurozone are far from over, and could yet lead to disaster. This is not a wish, you understand: more of a fear.

Now we all know that real incomes have been badly squeezed. I hope I could be as confident as the Bank that they will suddenly become a driving force of recovery. But if they are right, then a recovery of around 2% a year could easily be sustainable.

What could wreck things is if the house-price boom that the chancellor is cynically encouraging produces the kind of bubble that Carney and co do not yet detect, and panic increases in interest rates become needed. One of the assumptions that lies behind forward guidance is the belief that micro measures (although they are officially called "macro-prudential") can control the property market and delay the need for any rise in rates.

So, we have a recovery of sorts, although Labour will rightly want the fruits to be more equally divided than in recent years. Meanwhile I have to take issue with certain writers on the Financial Times– not, I hasten to emphasise, Sir Samuel Brittan or Martin Wolf – who have been suggesting that we Keynesian critics, including shadow chancellor Ed Balls, did not want a recovery and have been proved wrong because there is now a recovery.

We all wanted a recovery. It is just that, although there were certainly other factors behind the depression, the recovery was seriously delayed by the introduction of austerity programmes all over Europe, and not least in the UK.