If we take a step back from the present turmoil we can see a bit more clearly. Over the last 20 years the global economy has made huge strides.

But, inevitably, the cycle was bound to peak one day. Rising commodity and fuel prices were probably the trigger, but there is also the fundamental phenomenon of economic cycles where businesses and governments over-extend during good times to a point where small triggers appear that create confidence and expectation changes that, in turn, lead to cuts in investment and trading – markets "top out" in the jargon.

During this period Britain's politicians enjoyed rising tax revenues from growth, low interest rates allowing for investment, and low inflation courtesy of an independent central bank. Crucially, no UK government has had to deal with a major downturn when an independent central bank has been in place.

It seems to have been forgotten that one of the reasons for making the Bank of England independent was to stop politicians from meddling, to tighten the non-political control of our money so that inflation was kept permanently low. It is well recorded that, before central bank independence, pre-election booms were being used to retain power – leaving interest rates in the hands of politicians was simply unwise. Politicians, it was argued, would have to use tax as a governor of economic activity, and tax changes are much more politically transparent to voters than interest rate changes.

Over the past 10 years, few challenged Gordon Brown's famous claims about his prudence with the public finances. Well, Brown's poor stewardship has rebounded with a vengeance now. The Government claims that it cannot be held responsible for external shocks, citing oil costs and the sub-prime debacle. That is bunkum. Gordon Brown set up spending plans that support juggernauts like the NHS, welfare support and education without any financial reserve. He borrowed the money to do it on a whim and a prayer about growth. Government spending plans are the opposite of prudence, they are rigid, politically motivated and hugely difficult to claw back, especially where trade unionism is thriving inside the public sector. The private sector has both flexibility in its labour force and a long-term planning horizon, this government is hamstrung by having many of its own voters in the public sector and a five-year election cycle.

And so along came the shocks. The private sector reacts to rising fuel costs, raw material costs and interest rates rapidly. The economy moves towards low or no growth. But the government leviathan ignores realities – it ploughs on and the deficit soars. There is not even a glimmer of cost cutting in the public sector. Indeed, the indications are that some sort of neo-Keynesian infection has taken hold in Whitehall with claims that public spending is needed to maintain "economic stability". Whatever happened to Jim Callaghan's statement in 1976 that "we used to think we could spend our way out of trouble. Well, we now know we can't"?

The reality is that there are only three types of money; yesterday's money, today's money and tomorrow's money. Banks and governments recognise this quite differently. The banks use yesterday's money (savings collateral) to lend to business to earn today's money (earnings) and so create tomorrow's money (dividends). Today's financial crisis is partly based on a lot of yesterday's money turning out to be missing; false or non-existent collateral.

The banks have reacted sensibly by not lending. And because all of them have done this, interbank wholesale lending has locked up.

To break out of the logjam, the Government has offered to pump money into the system. Unfortunately, the Government through its own profligacy has neither yesterday's money (more borrowing) nor today's money (more tax) available. Instead it has to use tomorrow's money. Sadly, where new growth is not in prospect, tomorrow's money carries a poison – inflation.

The bailout process being carried through the markets today relies on the money becoming available to pay for it later. By far the easiest way for politicians to finance any shortfall is through inflation. The pressure for a new inflation will depend on how much of the new liquidity stays as just that, money traded inside the financial sector and held in short-term assets. The issue comes when new liquidity releases a new capacity for longer-term loans. It's those new loans that carry the poison. If they allow successful new activity to emerge in sectors that can raise prices, inflation will burst out into the larger economy.

There is little the Bank of England can do about this. Its interest rate capability is a retrospective blunt instrument at best. When it uses it retrospect-ively, we face stagflation; slightly high inflation with slightly high interest rates and very low growth. There is a worrying consensus among policy pundits that interest rates are all that matters to economic success. The reality is that the original intent of central bank independence was correct; the onus for creating success is moved firmly on to tax policy.

Tax policy needs to be used to generate growth. Only self-generated growth created by new private capital generating new private earnings will mop up excess money. The public sector takes up too much of the economy; its waste and profligacy are inefficiencies that drag down the private economy. Its momentum creates a rightly held anticipation of future over-spending. It needs to be cut back, with more of its activity handed to competitive markets and allowed to fail or succeed there.

Taxes need to be cut – deeply and quickly.

Eben Wilson is editorial director of the Taxpayers' Alliance