A former Conservative Treasury minister rounded on the government’s economic policy on Monday, calling the level of interest rates “ridiculous” and its management of the Budget “nuts”.

Lord Jim O’Neill, who was brought into government by David Cameron and George Osborne in 2015, argued that the government should spend much more on education, health and devolution and should limit any inflationary pressures with much higher interest rates.

But although O’Neill, who was previously chief economist of Goldman Sachs, was highly critical of the government’s monetary and fiscal policy, he supported Boris Johnson’s levelling-up white paper, saying it was “one of the most important things to come out of government for a long time”.

However, O’Neill spent almost no time talking about levelling-up and instead criticised general government economic policy.

He told MPs on the Commons Treasury committee that the Bank of England had made a mistake in being so late to see the danger of inflation, saying the rise in spending, which pushed prices higher after the coronavirus crisis eased, was “one of the most predictable recoveries we’ve ever had” .

O’Neil said he would have voted for raising interest rates and ending quantitative easing throughout the past year because the recovery was so strong. “It seems quite clear not just the Bank [of England] but other central banks should not have behaved as they’ve done in the past two years,” he added.

In an outspoken session, O’Neill was clear that he thought UK economic policy should be rebalanced so that government borrowing and public investment was higher and the additional demand was offset by higher interest rates to keep overall spending and inflation under control.

“I personally believe the whole framework for inflation targeting has outlived its sell-by date,” O’Neill said. Calling instead for “a shift in the mindset” and much higher government investment and “massive devolution”, he asked: “why is there such confidence in the need to get the deficit down?”

“If [government] debt went to 100 per cent [of national income] as a consequence of us having a proper structural approach to education spending so that we do not have the severe number of people who cannot do what they should [be able to] do [coming] out of our primary and secondary schools . . . I would positively welcome it”.

As well as calling for much bigger deficits and higher government investment, he told MPs that interest rates, which rose to 0.5 per cent last week, “are at a ridiculous level” and the BoE should be thinking “of a goal of interest rates of 4 per cent”.

“The government has to get out of the jail-like prisoner of circumstances and make sure the trend rate of growth doesn’t keep falling,” O’Neill added.

The former Treasury minister also said there had to be a better way to formulate the Budget than to rely on the Office for Budget Responsibility to forecast the deficit and then respond either with a windfall of spending or with austerity.

“It’s a mad situation where the biggest change in the next year’s Budget outcome is simply because three people at the OBR have changed the economic forecast,” he said. “It’s completely nuts.”

The other economists giving evidence alongside O’Neill disagreed about the causes of inflation and the BoE’s culpability, but all suggested that greater government investment in education and infrastructure had the best chance of increasing the UK’s underlying rate of productivity growth.

Roger Bootle, chair of Capital Economics, said the BoE had been too slow in addressing inflation, which is set to rise to 7 per cent, and people would naturally seek pay increases to match.

Jagjit Chadha, director of the National Institute of Economic and Social Research, said it was “critically important” that the BoE act to bring inflation down with higher interest rates without causing a recession.

Ann Pettifor, director of Prime Economics, disagreed, saying high inflation was primarily caused by an increase in freight, energy and fuel prices, and that “the BoE can’t be held responsible for that”.