Combining cheaper sterling with austerity may not work this time because recession, inflation and trade are of the 'wrong' sort

Sir Stafford Cripps could do it. Roy Jenkins managed it again, in the late 1960s. Ken Clarke joined the club of chancellors who used a combination of cheaper currency and austerity to rebalance the economy. So how come George Osborne lacks the magic touch?

The theory is simple. When the economy gets completely out of whack – as it did in the late 1940s, mid-60s and early 90s – the warning signs are either an overheated domestic economy or a poor export performance, and normally both. The excesses are killed off by higher interest rates, with slower growth pushing up unemployment and reducing cost pressures.

Once the economy has been hosed down, policy is loosened. This takes the form of an easing of monetary policy – lower interest rates and cheaper sterling – to stimulate business investment and exports. Faced with the risk that any pickup in activity will lead to higher consumer spending and a bigger imports bill, chancellors keep fiscal policy – tax and public spending – tight. Hey presto: the economy rebalances.

Cripps achieved this by a combination of rationing and (progressive) taxation. Jenkins did it through incomes policy and credit controls. Clarke (and Norman Lamont before him) raised taxes steeply in the two budgets in 1993 to ensure the benefits of Britain's departure from the exchange rate mechanism were not frittered away.

Osborne has approached rebalancing similarly. Monetary policy has never been looser; the main interest rate has been at 0.5% for the past four years and the depreciation of sterling since the financial crisis began has been bigger than that in 1949, 1967 or 1992. Fiscal policy has been kept tight, while wage bargainers' inability to get above-inflation pay increases has meant the statutory incomes policies of the 1960s and 70s have been replaced by something less official but just as effective in stopping consumer spending let rip.

And yet, there has been nothing like the snap back seen after previous recessions. There has been no growth at all, let alone the export-led growth that the Treasury and Bank of England were looking for. The economy has not rebalanced; it has simply lain down and died.

Sir Mervyn King, at last week's Bank of England inflation report press conference, suggested a reason for this: it had not been a normal recession and so would not be a normal sort of recovery.

What King meant by this was that the slump of 2008-09 was caused by too much debt rather than, as has usually been the case in the recessions since the second world war, excessive demand. Companies and households borrowed too much and have been de-leveraging since the financial crisis began.

In the case of households, this is proving a slow process. Household debt rose from about 101% of national output at the start of 1997, to 169% in mid-2007. By the third quarter of 2012 it was down to 144% of GDP, so the de-leveraging process has some way to go.

In the past a bit of inflation helped float consumers off the rocks of debt, so the Bank not hitting its inflation target in four years and intending to adopt a "flexible approach" to hitting it in the future, ought to be good news. Except it isn't. Just as the UK has been through the "wrong" sort of recession, it's now got the "wrong" sort of inflation.

Two kinds of inflation help erode the real value of debts: that of wages and that of property. In the past Britain has had a bucketload of both of them, but not this time. House prices are down by more than a quarter in real terms since their peak, but the bigger problem has been the inability of wages to keep pace with cost of living increases.

In part, the cost of living is rising because global commodities such as oil and food are dearer. An explanation is that depreciation in the value of the pound has pushed up imports costs. But higher inflation has also arisen from government decisions to push up VAT to 20%, and to triple university tuition fees.

The Bank and the Treasury are having a bit of a spat about who exactly is responsible for the inflation overshoot. Not me, says the governor, pointing the finger at the chancellor for the increases in so-called administered prices like tuition fees. Osborne, meanwhile, maintains he has scrapped rises in fuel duties and frozen council tax to keep inflation down.

In truth, neither Osborne nor King is blameless.

It was a mistake by the Treasury to push up VAT when commodity prices were rising, but the Bank's conduct of monetary policy has also been a factor. It has encouraged a fall in the value of sterling and has been part of the global quantitative easing programme, which has had more of an impact on asset and commodity prices than it has on activity.

As Stephen Lewis, of Monument Securities, says: "Prices are not responding to rising wages but rather reflect higher commodity costs, companies' quest for fatter profit margins and increases in administered prices.

"Monetary stimulus in these circumstances is likely to have its initial impact in boosting commodity prices further and in weakening any lingering inhibitions companies may feel about putting up their selling prices. The net effect may be to squeeze households' real disposable incomes even further."

This brutal squeeze on living standards might be deemed worth it if exports were booming. The government could then point to a current account healthily in the black, and say rebalancing is on track.

But this isn't happening either, because not only does Britain have the wrong sort of recovery and the wrong sort of inflation, it also has the wrong sort of trade.

Traditionally, the UK has run a whopping deficit in trade in goods, partially offset by a surplus in services. The latest data shows that this is the case, but beneath the surface the picture is a bit more complex than it seems. As the Bank showed in last week's inflation report, the big depreciation in sterling has arrested the UK's declining share of goods imports to its main trading partners. In contrast, the UK's services share, rising fast in the bubble years, has been falling.

This suggests that rebalancing the economy will require a further fall in the value of sterling together with a broadening of the UK's narrow economic base.

The pound has already fallen sharply in recent months as investors have started to question Britain's "safe haven" status. This process has further to go, and will add to inflationary pressure. By this stage in previous cycles, the squeeze on consumers had eased. Not this time, though.