Family gatherings have a habit of sometimes turning into deep political learning experiences – especially when you have a large extended family. At such an occasion in early March, a relative of mine opened up. He told me that he had voted Liberal Democrat last year. However, he would never vote Liberal Democrat again – or at least not while Nick Clegg was leader. So far, so good. But where the conversation went next was far more interesting.

While he wouldn’t be voting Liberal Democrat next time, he wasn’t at all sure about Labour. His concern was economic. Yes, the global financial crisis hit. Yes, we all had some responsibility – we knew that when we were maxing out on credit cards and mortgage debt that it was too good to be true. But you guys – Labour – don’t seem willing to take responsibility. And until Labour did, he wasn’t going to feel able to support them.

The latest YouGov polling shows that 42 per cent still blame Labour for the cuts against 25 per cent who blame the coalition (21 per cent blame both). Ipsos MORI finds that the Conservatives have a slender lead on the economy – 31 per cent against 28 per cent – but when you factor in the six per cent who back the Liberal Democrats on economic matters as well, it’s more of an uphill battle for Labour.

The views of Liberal Democrat supporters will be especially relevant should the referendum to introduce the Alternative Vote pass next month. Their second preferences would determine the next government. In an ICM voting intentions poll, which showed a slender 37-36 Conservative lead over Labour in the aftermath of the budget, the views of Liberal Democrat voters were laid bare. Among voters who are still Liberal Democrats, the coalition has a net 26 per cent positive rating – against -9 per cent for Liberal Democrat voters in 2010. Labour’s issue is that the economic war will be fought on two fronts at the next election with or without AV – though it is likely to be more pronounced with.

The Conservatives are already on the march. But they are led not by the prime minister. Nor are they led, or even particularly influenced, by his deputy. When asked in a recent Financial Times interview about how the budget would have differed had it been written by a Liberal Democrat chancellor, Clegg replied: ‘Not much. This budget was pretty close to what would have been delivered if I was prime minister and we had a Liberal Democrat chancellor.’ The Liberal Democrats may succeed in negotiating higher wealth taxes in the form of property taxes as a quid pro quo for ending the 50 per cent tax rate on upper earners, but little more.

No, the general is George Osborne. And he is the most political chancellor since, well, the last but one. The strategy is clear. First, take the political pain upfront. Second, draw back the state by removing as many people as possible from tax credits, public service reliance, and public sector employment. This is, in the mind of Osborne, unpicking Labour’s welfare ‘client’ state. You hope that the economy returns to growth and the political and economic cycles lock together. Then the coup de grace – a tax cut just prior to the general election which he wants to argue is possible because he has sorted out Labour’s mess and returned the economy to health. It hurt, it worked.

Unfortunately for Osborne, the scenario won’t be so politically or economically golden. Already, the Office for Budgetary Responsibility is hastily revising growth forecasts down while borrowing projections are being revised upwards – to the tune of an extra £44 billion according the budget red book. As wages are squeezed and imported inflation takes a further toll – including on public expenditure – the economy won’t recover with anything like the gusto that the chancellor is supposing.

This latest budget was an economic and political damp squib. The growth package was a mixture of: the underwhelming, like the under-capitalised Green Investment Bank; the largely ineffective, like new Enterprise Zones; and the wrongheaded. The most egregious of these was the Martin Sorrell tax break costing £5 billion per annum by 2015.

As the Work Foundation’s Will Hutton has argued: ‘Imagine not giving a damn about Mr Sorrell’s choice of tax jurisdiction or the value of his long-term incentive plan, and investing £5 billion a year in science and apprenticeships by 2015.’ There is the opportunity cost of giving away that £5 billion which may or may not be replaced in the short term by footloose multinationals. The opportunity cost then becomes permanent as other nations adjust their corporation tax codes. So the benefit – if there is any at all – is only short term. The missed opportunity for investment in long-term growth is huge and recurrent.

Whatever the short-term ebbs and flows, however, Osborne will be faced with an enormous dilemma. If he is to go for the tax cut he is desperate to make he will have two choices: to cut taxes and risk his fiscal credibility or pluck billions out of thin air. He is sitting on a very large asset: United Kingdom Finance Investments’ stakes in RBS, Lloyds TSB, Northern Rock and more. That could be his windfall to scatter round in advance of 2015 – though it is one-off, he could nonetheless hope to get away with it.

Labour will need to get ahead of this argument. One of its weaknesses for some considerable time is that it has been behind the political curve of the economic argument – probably since the G20 summit in 2009. When Osborne comes to sprinkle money around like confetti – either from the sale of the banks or by borrowing more – the framing must already have been established as one of fiscal irresponsibility. But to do that Labour must be heard more openly on the economy once again. This is unlikely to be just a case of shouting louder.

The party’s current strategy bases itself on time being a great healer, and the pain of cuts and austerity biting. Both Ed Miliband and Ed Balls have apologised for Labour failing to regulate the banks properly. The hope is that by apologising for a part, Labour may be forgiven for the whole. This may not be enough – like Osborne, Labour may also need a ‘Plan B’.

What would a Plan B entail? Up until now Labour has stuck rigidly to the line that it is not for oppositions to come up with detailed fiscal plans. I’m afraid this period may be the exception. It will involve political pain and that is part of the recovery. Moreover, Labour will have to establish a new and credible fiscal framework. A degree of honesty that Labour’s fiscal policy prior to the crash was too optimistic for good Keynesian and risk management reasons (as were Conservative plans to match Labour’s spending) could be a basis for presenting a new growth and stability fiscal approach. The creation of some form of independent fiscal authority might be a similarly smart move to Balls pushing for an independent Bank of England in 1997.

None of this is easy but economic credibility is a necessary condition for Labour to defeat the coalition. Osborne’s political strategy will bump up against the reality of his austerity economics. And yet that won’t necessarily mean that Labour becomes the natural choice for Liberal Democrat voters like my relative or the ‘mainstream majority’ who are disillusioned with the pace and scale of the coalition’s cuts and their failing economics. To become the next government of choice, it may need to show that it gets it, takes responsibility, and has a credible plan for the future. It won’t be easy but Labour has been brave before and it can be again.