Two calamities were announced last week. First came the news that Britain built fewer than 100,000 new homes last year, far below the 240,000 a year benchmark necessary to house our citizens and propel economic recovery. Then, and closely related, the credit rating agency Moody's, despairing at Britain's growth prospects and debt, downgraded Britain's AAA credit rating.

It is a profoundly sobering moment for everyone, confirmation of the self-defeating irrationality of George Osborne's policies whose purpose, he repeatedly claimed, were to preserve this very credit rating. But it also served warning to the Labour party of the extent of the economic challenge.

Britain is in the worst economic position in modern times and there is no simple way out. Multiple mistakes are coming home to roost.

The housing market represents the British disease that so worries international economic opinion. The crash programme of trying to eliminate the structural budget deficit within four years is not lifting housebuilding, any more than it is stimulating investment and innovation more widely. The incapacity to build reflects the crisis in macroeconomic policy, broken finance, the deadening overhang of mortgage debt and the squeeze on living standards. The basic unit of our productive system – the public limited company – no longer works and too few people work in firms that deliver the salaries and prospects to warrant taking on large mortgages.

On top of all this is a crisis of inequality, closing down the vitality of an open society. In housing, for example, it is increasingly the super-rich, many of them foreign, who are driving values at the top to levels impossible for most British people to meet, while the rest of the market languishes.

Policy has been geared to preserving a AAA credit rating on the basis that as long as interest rates are low, induced by a shrinking state careless about inequality, then the rest of the economy, including housing, would organise itself into recovery and even boom. It is a first-order debacle.

Inequality often feels too abstract a concern, or solely a problem for the poor, rather than a problem for all of us. Inequality is the preoccupation of the left, do-gooders and clergymen who overindulge "skivers" and do not celebrate "strivers". Housing gives the lie to these notions.

The housing sector stands and falls as a whole. The first-time buyer underpins the entire market and each transaction requires a chain of others. You may be a well-off "striver" in a leafy suburb, but when you come to sell your house your buyer will need to sell his or her house and another will have to do the same in turn. The housing market is thus a barometer of our entire economic and social health.

The greater the inequality, the harder it is to construct the chain on which healthy turnover depends, and the harder it is for first-time buyers to join the chain. Everything stops turning. Housebuilders, themselves under pressure from short-termist shareholders to deliver high financial returns, become cautious about building new homes for such an uncertain market.

The pre-crash long credit boom masked these strains: mortgage lenders would offer mortgages that were 100% or more of the property valuation and often to dubious credit risks. In the process, they lifted house prices well beyond what incomes could normally bear. No more. Poor credit risks are being shunned. Moreover, the prospect that middle earners' incomes will be 3% lower in 2020 than in 2008, as the Resolution Foundation's commission on living standards reported, is a further blow.

To make matters worse, the flow of first-time buyers in the decade ahead will be hit as ex-students defer purchase because they are shouldering £40,000 or more of debts from fees. British house prices, reckons the IMF, are up to 30% higher than they should be, measured by British income levels. Even allowing for government schemes, the bank of Mum and Dad, planning restrictions, low property taxation and all the other factors supporting prices, it is hard to imagine they can do anything other than decline in real terms in the years ahead.

What is clear in housing, as in the rest of the economy, is that there is no quick fix. The government's funding for lending scheme that makes lending a little cheaper, along with NewBuy, which provides mortgage guarantees for first-time buyers, seems to have eased tensions at the margins. But a full return to housing health requires much more. For a start, we should not compound income inequality with unequal property taxation. It is absurd that council tax is based on 1991 property values and the highest band means that only a handful of people pay more than £3,000, in real terms a fraction of what the rates yielded in the 1980s.

The Mirrlees Review, commissioned by the Institute for Fiscal Studies, advocates a new tax that would rise proportionally with property values and also the abolition of stamp duty, a tax on transactions. This would free up the market and yield billions more for local government. A mansion tax, pressed once again by Nick Clegg in today's Observer, and advocated last week by Labour, is a step in this direction. But these proposals need to embrace root-and-branch reform.

Coupled with this should be a public drive to build homes and not rely on indirect subsidies and financial guarantees. Central and local government must build homes on their own account. The doctrine that everything is best done by the private sector and the less built and owned by the public sector the better is not only nonsensical as an economic proposition, it is also socially noxious. Unless Britain can develop an innovation revolution, the real incomes of the semi-skilled and unskilled half of the population are going to fall as energy, food and commodity prices rise. For these people, the best option is to rent rather than buy overpriced homes and society has an obligation to meet that demand and, in the process, generate much-needed economic activity.

It is because fairer property taxation and a public housebuilding drive are anathema to George Osborne that neither will happen on his watch. Nor will the other initiatives vital to restore growth, including reform of the public limited company, the reframing of the financial system and a sustained narrowing of inequality. Macroeconomic policy will remain centred on impossible targets, designed to bring down public borrowing too fast. Moody's has delivered its judgment on the results. It won't be long before the electorate, struggling to house itself, follows suit.