Since the attacks on New York and Washington a month ago, the balance of US monetary and fiscal policy debate has been transformed for the first time in at least 20 years.

After two decades in which fiscal retrenchment was the guiding light of economic policy, from Wall Street to Capitol Hill there has been surprisingly widespread agreement on the need for a substantial fiscal stimulus to limit the economic damage from the attacks.

Even the Federal Reserve, which has come to be seen as the sole custodian of economic policy management, has joined in the calls for an activist fiscal policy.

Last month, Alan Greenspan, the Fed chairman, gave his blessing to Congress for a substantial package of tax cuts and public spending increases, telling members of Congress that a total stimulus of about 1 per cent of gross domestic product would be prudent.

Both the White House and the Republican and Democratic leadership in Congress have been careful to emphasise that there is a strict market-imposed limit to the fiscal largesse.

Both sides want to pass a stimulus package that will lift spending in the short term, but will not raise long-term interest rates by elevating concerns in financial markets that the government's long-term fiscal position is deteriorating too rapidly.

As Robert Rubin, the former treasury secretary, who has been advising congressional Democrats, puts it: "There is an indifference point where the negative effect on interest rates will outweigh the positive effects of the stimulus." Mr Rubin acknowledges that no one knows exactly where that indifference point is, but Democrats are fearful that it is about to be breached by proposals currently going through Congress.

Congress has already passed legislation authorising an additional $40 billion (€44.17 billion) of emergency spending for security and to help rebuild New York. In addition, it passed a $15 billion bail-out package for the airline industry. President Bush has said the extra stimulus should be no more than $75 billion, bringing additional impact on the economy to $130 billion, most of it in the current fiscal year. The president has also made clear he believes all the additional stimulus should come from tax cuts, not from spending.

Given that most estimates of the government's overall surplus this year have been whittled away already by weaker growth to about $150 billion, the extra measures Mr Bush proposes would probably eliminate the surplus this year. But most economists believe this is unlikely to have a significantly negative effect on long-term interest rates.

Though the figure is higher than that proposed by Mr Greenspan - it comes to about 1.5 per cent of GDP - the Fed chairman is said not to be unduly troubled by its effect on long-term borrowing costs.

But the bigger problem is not with the prospect of a fiscal stimulus that eats into surplus this year but with a tax-cut plan that would damage the nation's fiscal health further out.

Last Friday, the Republican-controlled House of Representatives Ways and Means Committee passed a stimulus plan that would have precisely that effect.

The committee's own estimate was that it would reduce the surplus by about an additional $100 billion in the current year. But it proposes to do so by bringing forward tax reductions planned for later years into the current fiscal year.

That would have the effect not only of reducing revenues in the next year but also of cutting them significantly below previous estimates for the next three to four years.

The Republicans' tax-cut plans, which enjoy the backing of the White House, would reduce all marginal rates in the current year to the levels that were supposed to be phased in gradually over the next four years. That would produce $27 billion in tax reductions this year as a stimulus, but at an overall cost of $122 billion in the next five years.

Since the purpose of a stimulus is to increase demand immediately, this seems to be paying a high price in terms of the long-term fiscal health of the nation - and possibly much higher interest rates - for a small gain.

Republicans argue that the tax reductions need to be immediate and permanent because otherwise, history suggests, businesses and consumers will tend to save the money rather than spend it.

Some also argue that the overall fiscal position of the government is not that significant in determining long-term interest rates. They point to the experience of Japan in the 1990s, where repeated fiscal stimuli resulted in a catastrophic transformation of the government's fiscal position, but long-term rates declined. Japan's government debt-to-GDP ratio is now over 125 per cent, double what it was a decade ago. But long-term Japanese government bonds are yielding less than 2 per cent, less than half the level of interest rates 10 years ago.

But Democrats argue that Japan's case is a special one. The country's long-term rates have clearly been driven by the 10-year-long slump and the weakness of prices - indeed deflation - which has heavily outweighed concerns about the over-supply of Japanese government bonds. And in any case, they argue, the damage to the economy from such a fiscal policy is not confined to the effect on interest rates.

"It's not just the effect on long-term rates," says Mr Rubin. "The more important factor is confidence. Once you lose control of your fiscal affairs it creates a general loss of confidence in economic management."

The Democrats' concerns are shared by many Republicans in the Senate and even by Republican leaders in the House. The White House, too, has expressed concern that the House bill may be too large in its initial effect on revenues and the surplus in the current year. And Democrats not only want any tax cuts to be limited to the current year only, they also want them to be targeted more towards lower-income groups.

Earlier this week, White House officials indicated their eagerness to continue to work with both parties to try to find an acceptable formula. But the administration is also eager to support plans that would accelerate the tax cuts already passed this year, which are the basic cause of the longer-term risk to the fiscal outlook. In addition, there is understandable political nervousness about passing tax cuts in the current fiscal year that would then be rescinded in 2002-03, just as the country is gearing up for a presidential election.

And all the time in the background is the near absolute uncertainty about how the economy will in fact perform in the next year. There is concern at the White House that if, as some economists argue, the economy remains very weak throughout the first half of 2002, the $130 billion in stimulus they have supported may not be enough. That would force them to seek further measures, a move that would involve an acknowledgment that the initial stimulus had failed.

In short, what looked like a surprisingly broad political consensus about fiscal policy was in fact illusory. Strikingly, most Democrats remain converts to the view that the interest-rate dividend from fiscal restraint remains generally greater than the immediate effects of fiscal expansion. Republicans remain committed, above all else, to permanent tax cuts.

President Bush is, in the interests of maintaining a united political front against terrorism, hoping to find a way to square this circle. But if he backs away from big tax cuts, he will raise suspicions among Republicans that his zeal for the war on terrorism is turning him into a backer of big government.

The alternative, however, could well be a loss of fiscal restraint that would quickly end the brief period of renewed faith in activist fiscal policy.