The governor of the Bank of England hit the spot on the state of our economy last week: "The zig-zag pattern of quarterly growth rates of GDP that we have seen this year is likely to continue." I agree with Mervyn King. We've had a good zig after three bad zags. Last quarter saw some growth again in services and manufacturing but construction just goes from bad to worse – down 2.5% over the quarter and 10% over the year. And at 7.5% of GDP it counts only slightly less than manufacturing at 10% these days.

The extreme reactions both ways to each quarter's flash GDP estimate show us that, four years on from his heart attack, the patient's still in intensive care. We hope he's healing, but we don't know. He's already had one relapse and there may well be more. What we do know is that he's stuck on a £375bn quantitative easing drip which is having ever nastier side-effects for savers and pension funds. And the economic patient is febrile and fragile at the same time – febrile here in central London, which feels more and more like an overheated island offshore from the rest of Britain – a tax-free funk hole for foreign billionaires, which is why a mansion tax is our top Liberal Democrat priority for fair tax you can't dodge. But the economic patient is all too fragile outside the posh parts of south-east England.

I've invested as a pension fund manager through three bad recessions in my career – in the early 1980s, and the early 1990s, but this one feels very different in three main ways: the banking system is still broken, housebuilding has collapsed to its lowest peacetime level since 1923 and real consumer incomes have fallen for three years in a row, against only one year in the 90s. No wonder output is still well below its 2008 peak when demand and confidence in the economy are so low. Twenty years ago, after Black Wednesday, despite high interest rates, small- and medium-sized companies with sound order books and prospects could borrow. But now Royal Bank of Scotland's excuse for not lending to SMEs "there is no demand for loans from creditworthy SME borrowers". Why then does Rolls-Royce have to lend £500m to its suppliers? If a small business supplying Rolls-Royce isn't creditworthy, who is, Mr Hester?

We must now nationalise RBS to do the job our nation needs. Taxpayers own 82% of the shares but we've had the worst of all worlds under both governments because the Treasury hides behind outside minority shareholders instead of controlling bank lending and bonuses.

Our coalition agreement's first item announced "we want the banking system to serve business, not the other way round". Fine words, but we haven't delivered. We said: "We will develop effective proposals to ensure the flow of credit to viable SMEs – including the use of net lending targets for the nationalised banks." We haven't and why don't we? Of course George Osborne inherited toxic banks from the last government. And the Vickers report represents real progress towards fundamental reform. But the credit's still not flowing and small business is still struggling two-and-a-half years on.

The IMF has pointed out that cuts in public investment and expenditure in western economies seem to make a much higher multiplier hit on the real economy than previously thought. As Vince Cable said in his Liberal Democrat conference speech last month, the need now is for demand stimulus.

What we need instead is a far bolder plan for economic recovery. I call it plan C for construction and capital investment rather than plan B but we can all agree at least, on this side of the debate, that Osborne isn't working. We must be mad to treat our record low long-term interest rates as some sort of virility symbol, instead of an unrepeatable opportunity to finance desperately needed investment.

The pension funds and insurance companies I act for, and know well, are desperate to find alternative secure long-term investments to meet their liabilities when returns are so paltry. Housing is the key, where building 100,000 more houses a year would create half a million more jobs. The infrastructure initiative George Osborne announced for pension funds a year ago has commitments of only £700m – that's the pace of a lame snail. The Treasury must be much more imaginative in helping facilitate new investment vehicles – which could easily raise £100bn or more of secure long-term funds – and ease the revenue squeeze on councils and housing associations for a massive social house building programme. Scrapping building regulations and planning permission isn't the answer – it's all about money.

We must confront Treasury orthodoxy and inertia now to make our banks lend and builders build. If we fail, we will be stuck in a stagnant economy and an ever more divided society.

• A version of this article was delivered by Matthew Oakeshott in Central Hall, Westminster on Monday evening, 29 October, seconding Alistair Darling for the motion "Osborne isn't working", against Lord Lamont and Jesse Norman MP