How Keynesians Got The US Economy Wrong… Again
Rising Growth Defying the Pessimists (VIDEO)
By Daniel Lacalle
In the past six months, a chorus of analysts and commentators warned of an impending collapse of the US economy.
Many predicted that persistent inflation, high interest rates, and ballooning government deficits would drag growth to a halt and trigger a recession.
However, the data tell a different story: the United States demonstrates economic strength, fiscal control, and improving inflation expectations.
Rising Growth Estimates Defy the Pessimists
At the start of 2025, forecasts painted a gloomy picture. The first quarter saw a contraction in GDP, with the US economy shrinking by 0.5%. However, this decline resulted from lower government spending and higher imports, while the private sector continued to strengthen. Soon afterward, the narrative shifted. By mid-year, leading economic models and analysts began revising their growth estimates upward. Trading Economics, for example, projected a robust 3.5% GDP growth rate for the second quarter, a sharp reversal from earlier pessimism. The Atlanta Fed’s GDPNow model reflected a similar positive change, estimating 2.6% growth for Q2 as of July 9. Additionally, consensus estimates rose to 2.1% for the second quarter, up from 1.3% previously, while inflation estimates declined.
This turnaround has been fueled by several factors:
- American households continued to spend, especially as wage growth outpaced inflation.
- Fixed investment rose by 7.6% in early 2025, the strongest pace since mid-2023.
- Businesses front-loaded imports ahead of new tariffs, boosting economic activity, and subsequent revisions showed positive exports and normalized imports.
These widespread upward revisions have caught many commentators by surprise and forced a re-evaluation of earlier bearish calls.
Inflation Expectations Are Falling
Another area where analysts misjudged the economy is inflation. After years of elevated price pressures, many expected inflation expectations to remain stubbornly high. Instead, recent data show a clear downward trend: consumer price inflation has declined on a one-, three-, and six-month basis. US consumer inflation expectations for the year ahead fell to 3% in June 2025, down from 3.2% in May—the lowest level in five months. Three-year and five-year inflation expectations also edged down to 3.0% and 2.6%, respectively.
Energy costs have declined significantly, with gasoline prices falling by 12% year-over-year in May and fuel oil prices dropping by 8.6%. Shelter inflation—a key driver of overall CPI—has also eased, with the rate dropping to 3.9% in May from 4% in April. Monthly price increases have been modest, with the CPI rising just 0.1% in May and forecasts for June suggesting a 0.23% monthly increase, keeping inflation at the lowest level in five years and, according to Truflation, running at a 1.7% annualized rate in June.
The broad-based decline in inflation expectations reflects the strength of the US supply chain, a slowdown in housing costs, and a decline in essential food prices.
The June Budget Surplus: A Fiscal Surprise
Perhaps the most dramatic evidence that analysts underestimated the US economy came in June, when the federal government posted a budget surplus of over $27 billion—the first monthly surplus since 2017. Consensus had widely expected a deficit of more than $40 billion.
The surplus was driven by two key factors:
- A sharp reduction in spending, as government expenditures fell by $187 billion in June due to aggressive cost-cutting measures and a reduction in the size of the federal workforce.
- Customs duties soared to $27 billion in June, up from $23 billion in May and more than quadruple the level from a year earlier.
Receipts rose by 13% compared to the previous June, while expenditures dropped by 7%.
Spending Cuts and Fiscal Restraint
The fiscal turnaround has also been powered by a significant reduction in non-defense discretionary spending. President Trump’s 2026 budget proposal slashed non-defense outlays by $163 billion, or 23% from the previous year, bringing spending to its lowest level since 2017.
While the broader federal deficit remains large—over $1.34 trillion for the year to date—it is mostly a legacy of the previous administration’s policies and is expected to fall significantly for the year. The lower deficit in May, along with strong April and June surpluses and spending cuts, has provided positive breathing room and challenged the narrative of runaway fiscal irresponsibility.
A Lesson in Humility
The events of 2025 remind us of the risks of Keynesian economic forecasting and the fallacy of ceteris paribus analysis (all else remaining equal). While challenges remain, especially regarding long-term debt and interest costs, the US economy has once again proven more dynamic and adaptable than many experts anticipated, and the administration’s focus on fiscal responsibility is clear.
Rising growth estimates, falling inflation expectations, budget control, and disciplined spending cuts highlight that earlier fearmongering estimates were ideologically motivated. The lesson from this experience is to approach economic forecasts with caution. Keynesian estimates often prove overly optimistic regarding growth and inflation when government spending increases and predict gloom when the opposite happens.
The US economy is stronger, and the private sector is likely to grow faster as tax cuts and deregulation lift burdens on investment and employment.
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About Daniel Lacalle
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Header featured image (edited) credit: OkDiario article tease/open card. Emphasis added by (TLB)
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