Vince Cable: Warning: this economic crisis could drag on for a decade

The issue remains whether the actions taken match the scale of the disaster

I sometimes hear the criticism that I – and other politicians – shouldn't "talk us into recession". There is a real dilemma. Do we try to be positive and risk misleading people through complacency; or do we "tell it like it is" and risk adding to the fear and financial panic?

On balance, it is better to be straight. And that means admitting that no one fully understands the scale of the complex but extreme economic crisis we face or has any simple, silver bullet, solution to it. The problems are partly international – the "credit crunch" – and partly national.

The latter is a legacy of a long period of economic growth built on debt financed household consumption and a grossly inflated bubble in house prices. Both of the international and home grown problems are difficult; together they are potentially lethal. I believe we face a real emergency. And it will not be over soon. This crisis could drag on for a decade.

It is necessary to look into history and dusty economics textbooks to find precedents and rules of engagement. There are several broad principles to prevent a recession from turning into a prolonged slump with falling or stagnating incomes, large scale unemployment, and unsustainable government budgets. The first step is to use monetary policy – interest rate cuts – recognising, however, their limited reach at present.

A second priority is for government to provide a stimulus, through tax cuts and public investment. I accept, reluctantly, that additional borrowing is necessary to prevent a further downward spiral. While much excitement is being aroused by a British, temporary, fiscal stimulus of around £20bn, less than 2 per cent of GDP, in the US the new administration is talking about a stimulus of 4 per cent of GDP. And this in an economy with public debt worse than the UK.

One good way to impart a fiscal stimulus is through additional public sector investment in, for example, social housing or public transport. The Government has limited itself to bringing forward agreed, not additional, investment. Another route, which my colleagues and I favour, is through the differential spending impact of cutting taxes on the incomes of the low paid funded by removing tax relief and allowances favouring the wealthy.

Yet, even if a fiscal stimulus works there will be legacy costs on top of the serious deterioration in the cyclically adjusted public sector deficit and borrowing. There will now be a tight squeeze on the public sector for many years to come.

But the third, and most important, step relates to bank lending. The balance sheet – assets and liabilities – of a single major bank, like Barclays, is twice as big as the whole of government debt. Any management decision to contract lending to business significantly to conserve capital or to protect dividends and bonuses will wipe out the effect of any fiscal stimulus.

That is why the Government will have to get its hands dirty intervening more actively in financial intermediation. Having committed £37bn to recapitalise banks – with potentially more needed – and much more in interbank lending guarantees, the Government cannot walk away from direct responsibility. It must take seats on the boards of leading banks, not to micromanage them, but set strategy. As the recession unfolds the question will increasingly be posed: who gains and who loses? The embarrassingly dated slogan of the recent Conservative past – sharing the proceeds of growth – now has to be turned on its head: how do we share the pain? The pain will be most obviously felt by those facing house repossession and loss of jobs. It is right that priority is now given to stopping the former by finding alternative tenure arrangements. And for those losing their jobs there has to be generous support to cushion the impact and to help with retraining.

The neuralgic issue emerging is who pays the tax bill for the accumulated deficits, the bank "bail out" and the stimulus package. The battle lines are already being drawn as it becomes clear that "middle Britain" is being lined up to pay higher income tax through national insurance. There is a compelling case for a more egalitarian approach: a fairer sharing of the pain of recession. It involves a systematic attempt to lift large numbers of people out of direct tax and cut the tax burden at the lower end with an assault on the allowances and reliefs of the wealthy than the Government's tokenistic higher rate.

But while we argue about who pays the bill the central issue remains this: whether the actions being taken on interest rates, bank lending and fiscal stimulus match the scale of the economic disaster now unfolding. I fear they may not.

The writer is Liberal Democrat deputy leader and Treasury spokesman