New York Times columnist Paul Krugman recently chided President Trump for imagining he invented the metaphor of “priming the pump” during an Economist interview. Yet Krugman, like Trump, buys into the premise that budget deficits really do “stimulate” total spending or “aggregate demand” which is commonly measured by growth of Nominal GDP (NGDP).
Economic booms and busts clearly have huge effects on budget deficits, but where is the evidence that deficits and surpluses have their own separate (“exogenous”) effect on NGDP?
To isolate cause and effect, we have to take out the “endogenous” effects that ups and downs in the economy have on taxes and spending. That is why the Congressional Budget Office (CBO)estimates budget deficits or surpluses (divided by GDP) without automatic stabilizers, which has traditionally been called the “cyclically-adjusted” budget. I will label it the “C-A Deficit” for short.
The red line in the graph shows the CBO’s Cyclically-Adjusted (C-A) deficit or surplus as a share of GDP. The blue line shows the percentage growth in Nominal GDP (NGDP).
From 1965 to 2016, the C-A Deficit averaged -2.7% of GDP, and growth of nominal GDP averaged 6.6%.
Contrary to 1960s Keynesian orthodoxy, the graph and table reveal no connection between the size of cyclically-adjusted deficits or surpluses and the rate of growth of aggregate demand (NGDP). From 1991 to 2001, for example, the C-A Budget swings from an average deficit to a sizable surplus with essentially no change in the pace of NGDP growth.
There is no measurable or even visible connection between larger CA-Deficits and faster NGDP growth in 2009-2012, nor between budget surpluses and slower NGDP growth in 1998-2000. For more than 50 years, our experience has frequently been the opposite of what demand-side fiscalism predicts. This is not just a short-term phenomenon.