Is the US economy in a dangerous downward spiral, or is this a painful but ultimately healthy adjustment leading to a sustainable growth path? Misdiagnosing this recession could have devastating consequences for the economy. If it is in a self-perpetuating spiral but Washington doesn't respond with massive stimulus spending, it could fall into a trough that would rival the Great Depression. If, on the other hand, it is naturally finding a bottom, heavy spending could jack up inflation dangerously and saddle future generations with a huge burden of debt.
With US unemployment at a 26-year high of 8.1 per cent and hopes for a second-half recovery waning, Congress is deeply split over how to interpret and cope with the crisis. On 10 March, the House Speaker, Nancy Pelosi, said "we have to leave the door open" to even more spending than is in Barack Obama's newly passed $787bn (£540bn) stimulus plan. But Senate Minority Whip Jon Kyl warned the same day against wasteful government spending. Senator Kyl had earlier accused Mr Obama of "rather casually throwing out some careless language" after the President warned Congress that failure to pass the original stimulus Bill would jeopardise the economy.
Unfortunately, economists aren't much help in this debate. They're tussling over the stimulus like rival surgeons battling for the scalpel in an operating room. Nobel laureates took opposite sides in BusinessWeek interviews. Robert Solow of the Massachusetts Institute of Technology (Nobel 1987) said the only thing wrong with the administration's fiscal stimulus was that it was too small. But Edward Prescott of Arizona State University (Nobel 2004) argued that Mr Obama's stimulus measures "are depressing the economy".
Most economic forecasters, who are judged on accuracy rather than academic rigour, seem to think a stimulus is necessary. (But then, they've been wrong before.)
The median forecast of a broad range of Wall Street economists surveyed by The Wall Street Journal in February was that the Obama stimulus plan would save about a million jobs over the next year.
That has irked the stimulus sceptics, who doubt the wisdom of heavy-handed intervention. About 250 economists signed an open letter to Mr Obama saying: "It is a triumph of hope over experience to believe that more government spending will help the US today." They favour cuts in tax rates and a rollback of regulation to promote long-term growth.
The dispute goes back 75 years to the Great Depression and British economist John Maynard Keynes. Before Keynes, most experts believed that economies naturally tended toward full employment. But Keynes argued that an industrialised economy can spiral downward when job cuts depress consumer spending, causing businesses to cut more jobs and decrease investment, and so on. Only government can break that spiral by spending to lift demand, he contended.
Keynesian views held sway well into the 1960s. But academia's fear of instability began to ebb in the 1970s as a new wave of economists argued that consumers and businesses are rational and far-seeing, and not likely to be stampeded into recession. What's more, the argument went, government can't spend its way out of a recession because consumers realise that extra spending now will necessitate higher taxes in the future. They'll save more to prepare for that day, offsetting the stimulus.
This crisis has revived the debate, in intense form. Economists who advocate intervention to break a downward spiral have become much louder. George Akerlof of the University of California at Berkeley (Nobel 2001) and Irrational Exuberance author Robert Shiller of Yale University call for "truly aggressive measures".
In contrast, the most extreme academic opponents of stimulus say unemployment is mostly a case of workers asking for too much money – and will solve itself if wages are allowed to fall. Arizona State's Mr Prescott says; "People are getting a little more hungry for jobs. It's great I can get some work done on my house."
The US can't wait for economists to agree. Right now, the risk of doing too little probably outweighs the risk of doing too much, because if the economy gets too deep in a hole, it will be hard to climb out. There will be time for fights over theory when the crisis is over.
This article was sourced from the latest global edition of 'BusinessWeek'. www.businessweek.com