Kill or cure? US stimulus kicks up a storm

Keynes always divided academics. But now the fortunes of America are balanced on a knife-edge, battle is raging between economists.

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'.

Start your day with The Independent, sign up for daily news emails
ebooksAn unforgettable anthology of contemporary reportage
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Recruitment Genius: Digital Optimisation Executive - Marketing

£30000 - £35000 per annum: Recruitment Genius: The UK's fastest growing, multi...

Recruitment Genius: Financial Reporting Manager

£70000 - £90000 per annum: Recruitment Genius: A Financial Reporting Manager i...

Recruitment Genius: Payments Operations Assistant

£23000 - £25000 per annum: Recruitment Genius: They win lots of awards for the...

Recruitment Genius: Telephone Debt Negotiator

£13500 - £20000 per annum: Recruitment Genius: This nationwide enforcement com...

Day In a Page

Syria civil war: Meet the military commander who says his soldiers will not rest until every inch of their war torn country is free of Islamist 'terrorists'

‘We won’t stop until Syria is back to normal’

Near the front lines with Islamist-controlled towns where Assad’s troops were besieged just last month, Robert Fisk meets a commander confidently preparing his soldiers for battle
The inside story of how Bill Clinton built a $2bn global foundation may undermine Hillary's chances

The inside story of how Bill Clinton built a $2bn global foundation...

... and how it may undermine Hillary's chances in 2016
12 best olive oils

Extra-virgin, cold-press, early-harvest, ultra-premium: 12 best olive oils

Choosing an olive oil is a surprising minefield. Save yourself the hassle with our handy guide
Sepp Blatter resignation: The beginning of Fifa's long road to reform?

Does Blatter's departure mean Fifa will automatically clean up its act?

Don't bet on it, says Tom Peck
Charles Kennedy: The baby of the House who grew into a Lib Dem giant

The baby of the House who grew into a Lib Dem giant

Charles Kennedy was consistently a man of the centre-left, dedicated to social justice, but was also a champion of liberty and an opponent of the nanny-state, says Baroness Williams
Syria civil war: The harrowing testament of a five-year-old victim of this endless conflict

The harrowing testament of a five-year-old victim of Syria's endless civil war

Sahar Qanbar lost her mother and brother as civilians and government soldiers fought side by side after being surrounded by brutal Islamist fighters. Robert Fisk visited her
The future of songwriting: How streaming is changing everything we know about making music

The future of songwriting

How streaming is changing everything we know about making music
William Shemin and Henry Johnson: Jewish and black soldiers receive World War I Medal of Honor amid claims of discrimination

Recognition at long last

Jewish and black soldiers who fought in WWI finally receive medals after claims of discrimination
Beating obesity: The new pacemaker which helps over-eaters

Beating obesity

The new pacemaker which helps over-eaters
9 best women's festival waterproofs

Ready for rain: 9 best women's festival waterproofs

These are the macs to keep your denim dry and your hair frizz-free(ish)
Cycling World Hour Record: Nervous Sir Bradley Wiggins ready for pain as he prepares to go distance

Wiggins worried

Nervous Sir Bradley ready for pain as he prepares to attempt cycling's World Hour Record
Liverpool close in on Milner signing

Liverpool close in on Milner signing

Reds baulk at Christian Benteke £32.5m release clause
On your feet! Spending at least two hours a day standing reduces the risk of heart attacks, cancer and diabetes, according to new research

On your feet!

Spending half the day standing 'reduces risk of heart attacks and cancer'
With scores of surgeries closing, what hope is there for the David Cameron's promise of 5,000 more GPs and a 24/7 NHS?

The big NHS question

Why are there so few new GPs when so many want to study medicine?
Big knickers are back: Thongs ain't what they used to be

Thongs ain't what they used to be

Big knickers are back