With less than a month to go until Budget day, doubts over the government's austerity programme are growing. The National Institute of Economic and Social Research has forecast that the British economy will shrink this year. The Office for National Statistics has announced that, on the broadest measure, more than 6.3 million Britons are underemployed – the highest number since records began, nearly 20 years ago.
Even Moody's, arbiters of global finance, is no longer confident that the coalition's current strategy is working: on 13 February, the agency changed its outlook on the UK's prized AAA credit rating to negative, citing uncertainty over whether the coalition government's strategy of fiscal consolidation will succeed in reducing the debt burden.
All these doubts ultimately derive from a single source. Cutting public spending is not by itself a growth policy. Considered in isolation, it is an anti-growth policy. If it is the only policy on offer, it will eventually defeat itself, by undermining the revenue on which the government depends to balance its books. This much is almost universally accepted across the political and analytical spectrum - and so, as a result, is the need for a "twin-track" policy mix: one that offsets the effects of government attempts to reduce its wasteful spending with measures to promote growth.
But it is here, on the question of what these complementary, growth-oriented policies should be, that agreement ends - and where the coalition government's policies to date have proved unfit for purpose.
Mix and match
There are two basic approaches available. The first - and the one favoured by the government until now - is what we might call the "indirect" approach. This is to use monetary policy as the offsetting device. As fiscal policy is tightened, monetary policy is loosened - in the hope that private businesses and individuals will respond to lower interest rates by increasing their spending.
The second approach is what we might call the "direct" approach. Rather than relying on loose monetary policy to counteract the drag of fiscal consolidation, the government takes action itself - by cutting taxes or by increasing its capital spending even as it reduces current spending.
Which policy mix is best? Quantitative easing (QE) - printing money - is a growth policy. The willingness to resort to QE around the world after 2008 is certainly what stopped the slide into another Great Depression. But QE is not enough. As a recovery policy, it suffers from two snags.
First, its effect on aggregate demand is weak and uncertain. It is not enough for the central bank to print money; the money has to be spent. The piling up of corporate cash balances - more than 5 per cent of GDP in the United Kingdom - shows that the new money is not translating into increased spending. Some argue that this is a reason to expand QE. Judging by its most recent £50bn injection, the Bank of England's Monetary Policy Committee seems to agree.
However, unless people expect QE to be permanent - in other words, that the gilts bought by the Bank will never be sold again and that part of the public debt will therefore be monetised - they may well go on piling up cash in order to cover expected future taxes. So there is a limit to how far QE can be pushed.
Second, QE does nothing to improve longer-term growth prospects. People have started to understand that the UK needs a more balanced economy - one in which financial services are a lower share of GNP, for example. In so far as it succeeds in raising aggregate demand alone, QE simply freezes the existing structure of the economy at a higher level of output.
Exactly the same objections apply to the tax cuts being proposed by business leaders and some Conservatives. These cuts will put more money into people's pockets - but their effect on spending is less certain. Unless they are expected to be permanent, a large part of the additional money will be saved. Likewise, tax cuts of the kind being proposed are unlikely to do much to improve the balance of the economy: they just put more spending power at the disposal of the structure that already exists.
They have one additional disadvantage. Unlike QE, tax cuts would increase the deficit and, therefore, to be consistent with the government's overall deficit reduction plan, they would have to be matched by spending reductions elsewhere - which would mean further cuts in public services.
The first two snags can be avoided by an enlarged and accelerated programme of capital investment. This would inject demand into the economy directly without having to rely on the vagaries of a private banking system that is still deep in repair mode, or on the uncertain willingness of businesses and households to spend the proceeds of tax cuts. And rebalancing public spending towards the capital budget - rather than away from it, as under the coalition's current austerity plans - would also have strong collateral benefits.
In the short run, it doesn't matter whether the increase in aggregate demand takes the form of employing people to dig holes and fill them up again, giving every household a time-limited spending voucher or building a new railway. All that matters is that the overall level of spending in the economy is maintained - so that unemployment stops rising and, with any luck, begins to fall again. But from any longer-term point of view, increasing aggregate demand by capital investment is better, because it creates identifiable future assets that promise to fund themselves and improve growth potential.
Yet it does not overcome the third disadvantage, which is that it will increase government borrowing at a time when the markets are demanding that the government reduce its debt. So, like tax cuts, it will have to be matched by cuts elsewhere - and again at the expense of the public services.
That is why we have argued for a British Investment Bank with the power to raise money directly from the private sector, and which therefore does not add significantly to the government's deficit. The government's commitment would be limited to capitalising it: the bank's lending would be funded from the private capital markets. It would charge lower interest rates for its loans than ordinary commercial banks; while the long-term returns that it would offer investors - being higher than those obtainable from gilts - would meet the desperate need for higher yields by pension funds.
A further advantage of such an autonomous set-up would be to shield the investment programme from the so-called boondoggle effect - building, at political behest, roads and railways that lead nowhere and therefore have no passengers or freight. Although there would be an implicit state guarantee of returns, the record of public investment banks in other countries - such as the European Investment Bank, the Nordic Investment Bank and the German Kreditanstalt für Wiederaufbau - shows that if an institution is well run, these guarantees are never, or rarely, called upon.
A final question might be: if these investment projects are worth doing, why isn't the private sector already doing them? A complete answer would take us deep into the theory of "market failure".
Here, it is important to make only one central point: the uncertain prospects for recovery as well as the impaired balance sheets of banks and firms have generated a massive "flight to liquidity", with savings stuck in bills and gilts while the riskier projects on which growth depends go wanting.
A British Investment Bank operating on the principles above, with a cogent and adequately funded investment strategy embedded in its mandate, would be an ideal vehicle for attracting "frozen" savings into the mar-ket. It would help address the current deficit of confidence and certainty about demand directly, rather than just praying for spontaneous reignition.
In particular, a national infrastructure programme would not only make Britain a more efficient place to do business but could also contribute greatly to the rebalancing of the economy away from excessive reliance on the City of London and financial services.
In sum, while QE and tax cuts should not be excluded from the recovery policy mix, the main driver needs to be a programme of long-term capital investment. The simplest way to do this would be to use the government's balance sheet to bear some of the risk. But this will not happen under the current government. Fortunately, there is an alternative way of achieving the same objective.
On 21 March, George Osborne, in his Budget speech, should announce that he is transforming the Green Investment Bank into an institution that can make a macroeconomically significant - and direct - contribution to recovery and growth.
Robert Skidelsky is professor emeritus of political economy at the University of Warwick and author of "Keynes: the Return of the Master".
Felix Martin is a macroeconomist and bond investor, whose book "Money: the Unauthorised Biography" will be published in 2013