Why Fiscal Stimulus Programs Fail,

Volume 1: The Limits of

Accommodative Monetary Policy in
Practice 1st Edition John J. Heim
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Why Fiscal Stimulus Programs
Fail, Volume 1
The Limits of Accommodative
Monetary Policy in Practice

John J. Heim
Why Fiscal Stimulus Programs Fail, Volume 1
 John J. Heim

Why Fiscal Stimulus

Programs Fail,
Volume 1
The Limits of Accommodative Monetary
Policy in Practice
John J. Heim
Department of Economics
State University of New York
Albany, NY, USA

ISBN 978-3-030-65674-4 ISBN 978-3-030-65675-1 (eBook)

https://doi.org/10.1007/978-3-030-65675-1

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 To Roger Porter,
brilliant economist, policy analyst and advisor to presidents,
and also one of Harvard’s best teachers.
 Preface

This is the third of a five book series on the science underlying Keynesian
mechanics and the scientific basis for its policy prescriptions. In all these
books, results found in testing in one period of time, are discarded unless
they can be replicated in most others as far back as 1960, ensuring that our
results are good science, not just attractive—sounding theories or random
statistical results resulting from testing one model on one period of time.
The need for a series of science books like this is obvious: over 80
years ago Keynes coined his famous theory that the economy was funda-
mentally demand, not supply, driven, and that because of this, deficit
financed government fiscal spending and tax cut programs could stim-
ulate the economy. Yet, to this day, there is no unanimity of agreement
within the economics profession as to whether they work. This, I believe,
is because positions economists hold on the issue are not generally empiri-
cally based at all, but based on theory alone, or based on endless numbers
of sophomoric empirical studies of (say) investment, with no two models
tested containing the same variables, or for more than one time period.
Nary a thought given to the fact that you don’t have a scientific result
unless you have replicated; i.e., verified that the same model yields the
same results in all or almost all time periods.
If this continues to be the way economics is done, evaluation of
whether economics policies work will not have a sufficiently scientific basis

vii
viii PREFACE

to be anything but an intellectualized version of “he said/she said” argu-

ments heard in divorce courts. You can also think of it as an upgraded
version of the “talking heads” economics we hear on talk radio and TV.
By contrast, of the three science books mentioned above, the first is a
well-tested, well replicated, 56 equation empirical model of the economy
(“An Econometric Model of the U.S. Economy”, 2017), which compares
well known DSGE, VAR and Keynesian model of the economy during
the same period of time an concludes the Cowles (Keynesian) Model best
explains the variation in the economy since 1960 and does so equally well
for each decade since 1960! And similar results are found for the key
equations in the Keynesian model: consumption and investment, where
the models explain approximately 90% of the variation in those variables
since 1960. And again, the same models explain the data as well in one
decade of the 1960–2010 period as another, indicating the model is good
science, not just “talking heads” economics.
The second book, Crowding Out Fiscal Stimulus (2017), uses the stan-
dard economic models for investment and consumption from the first
book to test whether deficit financed Keynesian stimulus programs worked
over the 50 year period, 1960–2010, controlling for all other variables
which could also affect consumption and investment levels. It found little
or no evidence they did, and that the reason for the failure was that
deficit financing “crowded out” borrowing-based private consumption
and investment due to the need to finance the deficit from the existing,
limited, pool of loanable funds. Again, results were found replicable in
several time periods sampled, and were also replicable using a variety of
models.
The third book, the book presented here, using from 6 to 18 different
sample periods, reiterates the testing to see if deficit—finances stimulus
programs cause crowd out, and affirms they do.
But the main focus of this third book is on why accommodative mone-
tary policy by the Federal Reserve did not offset this crowd out problem
and ensure attempts at Keynesian stimulus did work. After all, the empir-
ical soundness of the underlying demand—driven theory of GDP deter-
mination was well established in the first of these books, and it implied
stimulus programs should work. And later additions to the theory estab-
lished that should crowd out problems arise, they could be offset by
“accommodative monetary policy” by the Federal Reserve. This means
the stimulus programs would work if the Fed increased the pool of loan-
able funds available to private borrowers by the amount it was reduced
 PREFACE ix

to finance the deficit. This book concludes the main reason fiscal stimulus
programs haven’t worked was the systematic decisions by the Fed, from
1960 to 2007, not too increase bank reserves, i.e., implement accom-
modative monetary policy, to anywhere near the extent needed to offset
the deficit.
Other problems limiting the effectiveness of the Feds accommodative
actions were its stubborn insistence on implementing the accommodative
policy though securities purchases mainly from investment banks, who
sell securities mainly to raise money to buy other securities, not to finance
consumer and business loans to buy real goods and services, which is the
business of retail commercial and savings banks.
This third book also looks at whether endogenous growth in the loan-
able funds pool, due to rising incomes and saving, or an increasing
marginal propensity to save, could help offset the crowd out problem
caused by deficits, and concludes it can. This explains why in some
periods, fiscal stimulus programs seem to work, despite inadequate Federal
Reserve action to increase the pool, while in others they don’t. Hence,
depending on the period picked, it provides good evidence for economists
on either side of the argument about the effectiveness of Keynesian
stimulus programs. It helps provide an explanation why the economics
profession has found it so hard to become of one mind on this topic.
Two additional books are planned for the future, with a goal of
providing in the five books strong enough empirical evidence on what
works and what doesn’t, to constitute an engineering—quality manual
on how the economy works, thereby getting macroeconomics out of this
deductive/faux empirical quagmire it has been in the last few decades.
The fourth book, which is nearly finished, explores in great detail how
well different combinations of increases in loanable funds, some by
the Fed, some endogenous, actually offset crowd out problems. It also
tests different definitions of loanable funds to see which works best. It
concludes the total national savings plus foreign borrowing provides the
best definition of loanable funds. It also concludes endogenous growth
is generally much more effective than Federal Reserve-induced (exoge-
nous) growth, presumably because it is more likely to be used for loans
to purchase real goods and services, and not the result of liquidity added
to the system mainly used to buy other securities.
Th fifth book, not yet stated, will be an effort to determine if the “neo-
classical synthesis”, the theory most commonly used to show how the
x PREFACE

economy melds from the Keynesian short run into the classical long run
can be empirically verified to exist.
When completed, I hope these five books will provide good reason to
reclassify macroeconomics from a series of different, essentially deductive
philosophies, poorly grounded in empirics, into a branch of engineering.
Toward that end, we may be making progress: The first citation of the 56
equation econometric model book was in an engineering journal spon-
sored by the Institute of Physics and dealt with production functions.
Engineers do a lot of economics. It is a good sign the engineering field
is finding it can confidently rely on replicable economic studies developed
using the scientific method.

Albany, USA John J. Heim

September 2020
 Contents

Part I Introductory Chapters

1 Introduction 3
1.1 The Crowd Out Problem and Accommodative
Monetary Policy 3
1.2 Individual Chapter Contents and Findings 6
1.3 Summary of Key Findings 10
References 12
2 Literature Review 13
2.1 Summary of Findings 13
2.1.1 Stocks and Bonds 14
2.1.2 GDP 14
2.1.3 Inequality 15
2.2 Detailed Findings 16
2.2.1 Assessment of Monetary Policy Effectiveness
in the Business Press 16
Stock Market Effects 16
Bond Market Effects 17
GDP Effects 17
Inequality Effects 18
2.2.2 Assessment of Monetary Policy Effectiveness
in the Academic/Professional Literature 19
Stock Market Effects 19

xi
xii CONTENTS

Bond Market Effects; Interest Rate Effects 21

GDP Effects 23
Effects on Inequality 32
2.2.3 Comparisons of Findings of the Professional
and Business Press 33
2.3 A Comparison of Cowles, DSGE, and VAR
Methodologies Used in Literature Review 34
References 37
3 Methodology 41
3.1 General Methodological Issues 44
3.1.1 The Importance of Replicating Results
Before Publication 50
3.2 Other Methodological Issues Specific to This Study 51
3.2.1 GDP Deflator Methodological
Adjustments 53
3.2.2 Reconciling Differences in Signs,
Significance Levels of Tests in Different
Time Periods 53
3.2.3 Mixing Periods of Budget Deficit (Crowd
Out) Increase and Decrease 55
3.2.4 Statistical Insignificance Caused by Lack
of Variation in the Data 69
3.2.5 Left-Out Variables 72
3.2.6 Multicollinearity 73
3.2.7 Insufficient Sample Size 74
3.2.8 Spurious Results Indicating Insignificance 75
3.3 How Should a Change in Loanable Funds Be
Distributed to Tax and Spending Deficits 75
References 77

Part II Theory of Crowd Out and Accommodative

Monetary Policy
4 Theory of Crowd Out and Accommodative Monetary
Policy 81
4.1 How, and Under What Conditions, Can Federal
Reserve Purchases of Government Securities
Stimulate the Economy 81
 CONTENTS xiii

4.1.1 Overview 81
4.1.2 Detailed Analysis of the Crowd Out
and Accommodative Monetary Policy
Processes 83
Accommodative Federal Reserve Purchases
from Depository Institutions 83
Federal Reserve Purchases
from Non-depository Institutions 84
4.2 A Formal Model of the Effects of Fiscal
Stimulus Programs, Their Crowd Out Effects,
and Accommodative Monetary Policy 87
4.2.1 Crowd Out Effects of Deficit Financing 89
4.2.2 How Accommodating Monetary Policy
Offsets Crowd Out Effects 90
4.2.3 Different Crowd Out Effects of Tax Cut
and Spending Deficits 94
Alternative Ways of Modeling Crowd Out
Effects 96
4.2.4 Declining Deficits Create “Crowd in”
Effects 102
4.2.5 Should We Use Accommodate Monetary
Policy to Offset Crowd Out? 103
References 105
5 A Simplified Balance Sheet View of How Open
Market Operations to Stimulate the Economy, When
Dominated by Primary Dealers, Actually Stimulate
Securities Markets, not the Real Economy 107
5.1 When the FR Goes into the Open Market and Buys
$1000 in Treasuries (T) from a Dealer/Broker
(Usually a “Primary Dealer”), The Dealer May
Be Paid by Check Drawn on the FR (FRck) (If
Dealer Is Paid Electronically by Fed Transfer
of Funds to Dealer’s Bank, Skip Steps 5.1–3 and Go
to Step #5.4) 108
5.2 Dealer #1Deposits FR Check in Dealer’s Own Bank 108
5.3 Bond Dealer’s Bank Cashes in the FRck at the Fed.
Assume Required Reserve Ratio (RR) = 10%
and Let Excess Reserves = (ER) 108
xiv CONTENTS

5.4 Bond Dealers Make Their Money Buying

and Selling Bonds. Bond Dealers (Generally)
Would Have no Incentive to Sell Treasuries
to the FR, Except to Obtain the Funds Needed
to Buy Another Security (Alt Sec) Expected to Pay
a Higher Return. This Is Bought from Dealer
#2 by Dealer #1 and Paid for with DD (Step
Involving Check Payment, and Conversion
to Reserves not Shown) 109
5.5 Bond Dealer #2 (Generally) Only Sold Alt Sec
to the First Dealer Because Dealer #2 Needed
the Liquidity to Buy Another Security (Alt Sec2)
that Looked More Promising, Which Dealer #2 then
Bought from Bond Dealer #3 Using the Proceeds
of the Sale of Alt Sec to Dealer #1 to Finance
the Purchase of Alt Sec2. the Cycle Continues
in Perpetuity Until no Other Dealers Wish to Sell
Securities at This Time. Results for Dealers #2
and #3 and #4 Are Shown Below (with Some Check
& Reserves Movement Intermediate Steps Missing) 109
5.6 The Final Result Is Shown Below, After All
Intermediate Steps Above Are Cancelled Out,
and Assuming Bond Dealer #4 Cannot or Does
not Want to Find Any Other Dealer/Broker
with Desirable Securities to Buy 110
References 113
6 A Money Multiplier Approach to How Open Market
Operations Stimulate Securities Markets and the Real
Economy 115
6.1 Simple Money Multiplier 115
6.2 A More Sophisticated Money Multiplier 116
References 122

Part III The Effectiveness of Accommodating Monetary

Policy Mechanics
7 The Role of Primary Dealers in Federal Reserve
Efforts to Change the Money Supply 125
7.1 Primary Dealers Dominate Auctions 126
 CONTENTS xv

7.2 What Type of Bank Does the Federal Reserve

Purchase Securities from: Investment or Depository? 126
7.3 The Failure of Federal Reserve Securities Purchases
During “QE” to Reduce Depository Institutions
Holdings of Government Securities, Which Would
Have Increased Their Loanable Funds 131
7.4 Primary Dealers and the Business They Are in:
Selected Years 1960–2014 134
7.5 Loss of Efficiency When Using Investment Banks
and Brokerages to Implement Accommodative
Monetary Policy 140
7.6 Primary Dealers Who Are Domestic Vs. Foreign
Corporations 141
References 145
8 The Failure of Accommodative Monetary Policy
Before Quantitative Easing (QE) and Its Success
After; the “Pushing on a String Problem” 147
8.1 Effectiveness of Accommodative Monetary Policy
1960–2007 147
8.2 Effectiveness of Accommodative Monetary Policy
2008–Present 153
8.3 Does “Pushing on a String” During QE Apply
to M1 as Well as Total Loanable Funds? 157
8.4 Conclusions 159
References 161
9 The Failure of U.S. Loanable Funds to Grow as Much
as Federal Reserve Securities Purchases During QE:
The Role of Foreign Banks 163
9.1 The Textbook Equivalence of Increases in FR
Securities Purchases and Increases in Loanable
Reserves 164
9.2 The Effects of Fed Purchases of Securities
from Foreign Dealer/Brokers 165
9.3 Trends Since 1960 in M1, Excess Reserves
and Currency in Circulation 166
References 174
xvi CONTENTS

Part IV Increases in M1—Effects on Stock and Bond

Markets and the GDP
10 Effect of FR Purchases of Government Securities
on M1 177
10.1 Relationship of M1 Growth to Growth in Securities
Purchased by the Fed 177
10.2 More Sophisticated Models of the Relationship
Between FR Securities Purchases and M1 187
10.3 Tests of the Relationship Between M1 and Excess
Reserves and FR Securities Purchases 191
10.4 Relationship of Growth in M1 to Growth
in the Monetary Base 196
10.5 The Most Theory Consistent Model of M1’s
Determinants 198
10.6 Summary of Results of Tests of Relationship
of Changes in FR Purchases to Changes in M1 199
References 205
11 Effect of Increases in Loanable Funds or M1
on the GDP 207
11.1 Simple Tests 207
11.2 More Sophisticated Tests of the Effects of FR
Security Purchases on Real GDP 212
11.2.1 Summary of Table 11.1 Findings 217
11.3 Testing Housing and Consumer Services Demand
for Sensitivity to FR Securities Purchases 220
11.3.1 Housing Investment Effects 221
11.3.2 Lagged Consumer Services Spending
Effects 222
11.3.3 Total Consumer and Investment Spending
Effects 222
11.3.4 Full GDP Effects 224
11.4 Summary of Results and Conclusions 226
References 232
12 Effect of FR Security Purchases and M1 on Stock,
Bond, and Mortgage Markets 233
12.1 Effect of FR Open Market Operations on the Stock
Market 234
 CONTENTS xvii

12.2 Effect of FR Open Market Operations on Bond

and Mortgage Markets 237
12.3 Do FR Open Market Operations also Affect GDP 242
12.4 Summary of Findings and Conclusions 244
References 245

Part V Does Crowd Out Really Occur?

13 Does Crowd Out Really Occur? Initial Empirical
Evidence: One Time Period 249
13.1 Consumption 251
13.2 Investment 253
13.3 Conclusion 254
References 254
14 Does Crowd Out Really Occur? Empirical Evidence:
Replication in Many Time Periods 255
14.1 The Heim (2017b) Study 255
14.2 The Heim (2017a) Study 256
14.3 Crowd Out Findings in This Study 258
References 260

Part VI Increases in Total Loanable Funds (S+FB)—Do

They Reduce Crowd Out?
15 Initial Tests of Whether Crowd Out Can Be Offset
by Increases in Loanable Funds 263
15.1 Methodology for Testing Increases in Loanable
Funds as an Offset to Consumption Crowd Out 264
15.2 Taxes: Another Variable That Has Both Positive
and Negative Effects on Consumption 269
15.3 Methodology for Testing Increases in Loanable
Funds as an Offset to Investment Crowd Out 270
15.4 Conclusions 273
References 273
16 Which Models Best Explain How Changes in Loanable
Funds Offset Crowd Out? 275
16.1 Effects on the Consumption Function 278
16.2 Effects on the Investment Function 285
References 290
xviii CONTENTS

17 Do Loanable Funds Modify the Crowd Out Effects

of the One-Variable Deficit (T − G)? 291
17.1 Consumption Results When also Including (S +
FB) as a Separate Variable 291
17.2 Consumption Results When not Including (S +
FB) as a Separate Variable 298
17.3 Investment Results When also Including (S + FB)
as a Separate Variable 301
17.4 Investment Results When not Including (S + FB)
as a Separate Variable 307
17.5 Comparing the Effects of Exogenous (FR Purchases
Induced) and Endogenous (Economic Driven
Change Induced) Loanable Funds Growth 310
17.5.1 Effects on Consumption 310
17.5.2 Effects on Investment 312
17.6 Conclusions 315
Reference 322
18 Do Loanable Funds Modify the Crowd Out Effects
of the Two-Variable Deficit (T), (G)? 323
18.1 Testing the Two-Variable Deficit Consumption
Model 323
18.1.1 Mixing Crowd Out and Crowd in Periods
May Distort Results 338
Adding a Separate, Stand Alone Loanable
Funds Variable to a Crowd Out Model 346
Can Table 18.1 Results Be Replicated
in Other Samples? 348
Heteroskedasticity (or Heteroscedasticity)
and Autocorrelations 360
18.1.2 Comparing One-Variable
and Two-Variable Deficit Results 362
18.2 Consumption Models Without Stand-Alone (S +
FB) 364
18.3 Crowd Out Effects on Investment Using Stand
Alone Loanable Funds Variable 368
18.4 Crowd Out Effects in Investment Models Without
a Stand Alone Loanable Funds Variable 377
18.5 Chapter Summary 384
 CONTENTS xix

References 389
19 Does M1 or Total Loanable Funds Better Measure
Offset Effects to Crowd Out? 391
19.1 Comparing Unmodified, LF Modified, and M1
Modified Deficit Variables 395
19.2 Adding a Separate, Stand-Alone M1 Variable
to the Model 400
19.3 A Note on the Relationship of National Savings
to M1 405
19.4 Summary of Results and Conclusions 407
References 410

Part VII Determining M1 Effects on Crowd Out

20 Does M1 or Total Loanable Funds More Accurately
Define the Extent to Which Crowd Out Can Be
Modified? 413
20.1 Testing the Consumption Model 414
20.2 Testing the Two—Variable Deficit Investment
Model 424
20.2.1 Investment Models with a Stand-Alone
Loanable Funds Modifier 424
20.2.2 Investment Models Without a Stand-Alone
Loanable Funds Modifier 431
20.2.3 Investment Models Without a Stand-Alone
Loanable Funds or M1 Modifier,
but with a Business Cycle Control Variable 433
20.3 Comparing Model Results with (Table 20.5)
and Without (Table 20.4) GDP Control 437
20.4 Summary of Chapter 20 Results 438
Reference 446

Part VIII Non-Black Box Models: Structural

Mechanisms Through Which Loanable Funds
Affects Consumption and Investment
21 Do Consumer Borrowing, Inflation, and Prime
Interest Rate Increase When M1 Is Increased? 449
21.1 The Consumer Borrowing Equation 450
xx CONTENTS

21.2 The Inflation Equation 455

21.3 The Prime Interest Rate Determination Equation 457
21.4 Summary of Findings and Conclusions 462
Reference 466
22 Effects on Consumer and Business Borrowing
of Loanable Funds and M1 467
22.1 Mechanisms Through Which Loanable Funds
Changes Affect Business Borrowing, a Determinant
of Investment Demand 468
22.2 Effect of Business Borrowing on Investment
Demand 473
22.3 Mechanisms Through Which Loanable Funds
Changes Affect Consumer Borrowing, and Through
Which Consumer Borrowing Affects Consumer
Demand 476
22.4 Effect of Consumer Borrowing on Consumer
Demand 485
22.5 Summary of Chapter Results and Conclusions 488
Reference 490
23 Effects on Inflation of Loanable Funds and M1 491
23.1 Testing for the Effects of Loanable Funds
on Inflation 491
23.2 Loanable Funds Relationship to M1 495
Reference 506
24 Effects on the Prime Interest Rate in Keynesian
Models of Loanable Funds and M1 507
24.1 In the Keynesian Interest Rate Model, Do Changes
in Loanable Funds Explain Changes in the Prime
Interest Rate as Well as Changes in M1? 507
24.2 Summary of Results and Conclusions 511

Part IX Summary Chapters

25 Summary of Introductory, Literature Review,
and Methodology Chapters (Chapters 1–3) 517
25.1 Chapter 1 Overview of Deficits, Their Crowd Out
Effects, and Accommodative Monetary Theory 517
25.1.1 The Crowd Out Problem 517
 CONTENTS xxi

25.1.2 Actual Accommodative Monetary

Policy—Chapters 4–9 518
25.1.3 Accommodative Monetary Science
Chapters 10–24 518
25.2 Chapter 2 Summary—Literature Review 519
25.3 Chapter 33: Methodology 519
Reference 520
26 Summary of Crowd Out and Accommodative
Monetary Policy Theory (Chapters 4–6) 521
26.1 Chapter 4: Theory of Crowd Out
and Accommodative Monetary Policy 521
26.2 Chapter 5: Balance Sheet Presentation of Theory
of Crowd Out and Accommodative Monetary Policy 522
26.3 Chapter 6: Money Multiplier Explanation
of Theory of Crowd Out and Accommodative
Monetary Policy 522
26.4 Chapter 7: The Role of Primary Dealers in Open
Market Attempts to Increase Loanable Funds
and the Money Supply 522
26.5 Chapter 8: Negative Effects of Excess Reserves
and Increased Cash Holdings on the QE Monetary
Stimulus Program: The “Pushing on a String”
Policy Problem 522
26.6 Chapter 9: Why Increases in Loanable Funds Are
Less Than Increases in FR Security Purchases: The
Role of Foreign Banks 524
27 Summary of the Science Underlying the Conclusion
that “Crowd Out” Is a Serious Problem
and Accommodative Monetary Policy Can Offset It 525
27.1 Do Federal Reserve Security Purchases Change
the Money Supply or the Monetary Base?
(Chapter 10) 526
27.2 Do Changes in the Money Supply Affect the GDP
or Its Components? (Chapters 11, 20–21) 528
27.3 Do Changes in the Money Supply or Monetary
Base Affect Prices in the Stock or Credit Markets?
(Chapter 12) 531
xxii CONTENTS

27.4 Does Stimulative Fiscal Policy Create a “Crowd

Out” Problem that Reduces Consumer
and Investment Spending, Causing the Fiscal
Policies to Be Ineffective? (Chapters 13, 14, 17, 18) 532
27.5 Does Growth in Loanable Funds Offset Crowd Out
Better Than Growth in M1? (Chapters 20, 21) 535
27.6 Do Increases in Total Loanable Funds Eliminate
the Crowd Out Effects Caused by Deficits?
(Chapters 15–18) 536
27.7 Which Part of Total Loanable Funds Growth,
the Endogenous (Economy Driven) or Exogenous
(Federal Reserve Policy Driven) Part Most
Effects the Real Economy and Financial Markets?
(Chapters 17, 22–24) 543
References 547
28 Summary of Engineering Equations in This Book 549
28.1 Effect of FR Securities Purchases on M1 550
28.2 Does M1 Affect GDP?—Simple Model (St. Louis
Equation) Results 550
28.3 Do Changes in M1 or Loanable Funds Affect
the GDP More—Using Scientifically Valid Models
(Table 20.5) 552
28.4 Do Deficits Really Cause Crowd Out? 554
28.5 Which Is a Better Measure of Consumer Crowd
Out? the Deficit, or the Deficit Reduced by Any
Same-Period Growth in the Pool of Loanable Funds
(1 and 2 Variable Deficit Model)? 556
28.6 Which Is a Better Measure of Investment Crowd
Out? the Deficit, or the Deficit Reduced by Any
Same-Period Growth in the Pool of Loanable Funds
(1 and 2 Variable Deficit Model)? 558
28.7 Do Endogenous or Exogenous Increases in Loanable
Funds Have the Most Success in Reducing Crowd
Out? 560
28.8 Do Increases in Loanable Funds Increase Consumer
and Business Borrowing? Does Increased Business
Borrowing Decrease Consumer Borrowing? 561
28.9 Effects of Increases in M1 on Inflation 562
 CONTENTS xxiii

28.10 Effect of M1 on Prime Interest Rate 562

Reference 562
29 Definitions of Acronyms Used 563

Part X Overall Conclusions

30 Overall Conclusions 569

Index 573
 List of Figures

Graph 2.1 Comparisons of Japan, Canada and the U.S 24

Graph 10.1 M1 regressed on FR securities purchases 1955–2016 182
Graph 10.2 M1 regressed on FR securities purchases 1955–2016
(W/O constant term) 183
Graph 10.3 M1 regressed on FR purchased securities securities
1955–2007 185
Graph 10.4 M1 regressed on FR purchased 1955–2017 186
Graph 11.1 GDP regressed on M1 1961–2017 208
Graph 11.2 GDP regressed on M1 (W/Constant) 1961–2017 208
Graph 11.3 GDP regressed on M1 1961–2017 210
Graph 11.4 GDP regressed on M1 (W/Constant) 1961–2017 211
Graph 19.1 Savings = ƒ(M1, FB)—predicted and actual 406

xxv
 List of Tables

Table 3.1 Calculating 2013–2017 real GDP using estimated

values of the base year 2005 chain deflator 54
Table 3.2 Simulated regression data 56
Table 3.3 Changes in regression coefficients and t-statistics
associated with loanable funds changes 59
Table 3.4 Average yearly increases (+)/decreases (−) in deficits
by decade 60
Table 3.5 Yearly changes in the deficit in the 1990s 62
Table 3.6 Simulation of deficit and surplus effects on sign
of government spending coefficients 65
Table 3.7 Effects of spending deficit growth on consumption 67
Table 3.8 Effects on consumption of loanable funds growth
less than spending deficit 67
Table 3.9 Effects on consumption of loanable funds growth
greater than spending 67
Table 3.10 Effects on consumption of declining spending deficit 68
Table 3.11 Trends in crowd out significance and movement
in other variables 71
Table 3.12 Ratio of standard deviation/average yearly change
in standard consumption function variables 72
Table 3.13 Single variable deficit significance in standard
consumption model (multi-decade samples) 74
Table 3.14 Coefficients of modified T ,G variables,
and stand-alone (S + LF) when (S + LF) distribution
varies 76

xxvii
xxviii LIST OF TABLES

Table 6.1 Money expansion resulting from a $430.8 billion

increase in national saving 122
Table 7.1 Firms from which permanent treasury security
purchases were made as part of the quantitative
easing program (Q1: 2016; Q1–4: 2014, 2012;
and Q3–4: 2010) 129
Table 7.2 Permanent treasury security purchases as part
of the quantitative easing program (selected
periods Q3: 2010–Q1: 2016) 130
Table 7.3 Depository institution holdings of treasury, agency
and GSE securities 132
Table 7.4 Total treasury, agency and GSE securities held
by depository institutions during the QE program
years 133
Table 7.5 Primary dealers and the business they are in: selected
years 1960–2014 135
Table 7.6 Q4: 2014 purchases of US securities by the Federal
Reserve: $10,517.5 million 142
Table 7.7 FR purchases of treasury and agency securities
and growth of the monetary base (billions) 144
Table 8.1 Excess reserves in U.S. depository institutions
during recessions and non-recessionary periods
(billions) 148
Table 8.2 Real yearly changes in the deficit (T – G) and FR
security purchases (Tr + A) (billions of 2005
dollars) 151
Table 8.3 Levels of accommodating monetary policy compared
to fiscal deficits in recession years during 1959–2017
(nominal values) 154
Table 8.4 Levels of real accommodating monetary policy
compared to fiscal deficits in recession years
during 1959–2017 156
Table 8.5 FR security holdings, reserves, M1 and monetary
base; average values before and during QE
(nominal values, billions) 157
Table 9.1 M1 trends, as a percent of GDP 167
Table 9.2 Excess reserves, currency in circulation and M1 168
Table 9.3 Additional excess reserves held during recessions
(billions) 170
Table 9.4 Excess reserves/total reserves ratio 171
Table 9.5 Credit market borrowing 2004–2011 all sectors,
by instrument (billions of dollars) 173
 LIST OF TABLES xxix

Table 9.6 Average yearly declines in borrowing average annual

borrowing in 2004–2007 compared to 2008–2011
(billions of dollars) 173
Table 10.1 Historical data: nominal treasuries held by FRB,
nominal M1 and real GDP (billions) 178
Table 10.2 Relationship of real FR purchases of securities to real
M1 growth in five time periods controlling for other
determinants of M1 growth (2005 = 100) 189
Table 10.3 Money multiplier estimates from Table 10.2 model 190
Table 10.4 Changes in real M1 associated with same period
changes in real excess reserves and two year average
changes in real FR securities purchases 193
Table 10.5 Changes in real M1 associated with same
period changes in real excess reserves and two
year average changes in real FR securities purchases 195
Table 10.6 Ratio of changes in real M1 to changes in real
monetary base 196
Table 10.7 Relationship of FR purchases of securities
to monetary base growth in five time periods
controlling for other determinants of monetary base
growth 197
Table 10.8 This chapter summary table effects of changes in FR
security purchases on M1 200
Table 11.1 Marginal effects of changes in FR Purchases and (M1
− FR Purchases) on Real GDP 214
Table 11.2 Chapter 11 summary table: Effects of changes in M1
on GDP 227
Table 12.1 Marginal effects of FR purchases on the NYSE
composite index 235
Table 12.2 Marginal effects of FR purchases on the NYSE
composite index, controlling for endogenous changes
to M1 237
Table 12.3 Marginal effects of changes in endogenous M1
and FR securities purchases on bond and mortgage
market yields and stock market prices 239
Table 14.1 Unmodified effects of deficits (crowd out)
consumption and investment 259
Table 16.1 Effects of different loanable funds offset models
on crowd out in consumption models 281
Table 16.2 Results of different investment models of the effects
of loanable funds on crowd out 287
xxx LIST OF TABLES

Table 17.1A Growth in explained variance when adding

unmodified crowd out to a standard model 294
Table 17.1 Crowd out effects on consumption,
with and without offsetting changes in loanable funds 297
Table 17.2 Here crowd out effects on consumption,
with and without offsetting changes in loanable
funds (no stand-alone S + FB) 299
Table 17.2A Growth in explained variance when adding crowd
out to a standard model 304
Table 17.3 Effects of crowd out on investment,
with and without loanable funds modification
of the deficit; stand alone variable included 306
Table 17.4 Effects on investment of crowd out,
with and without same-period changes
in loanable funds 308
Table 17.5 Endogenous and exogenous changes in loanable
funds: effects on consumption crowd out 311
Table 17.6 Endogenous and exogenous changes in loanable
funds: effects on investment crowd out 313
Table 17.7 Endogenous and exogenous changes in loanable
funds: effects on crowd out (GDP control
added to Table 17.6 model) 314
Table 17.8 Total loanable funds deficit modifier, W/WO
separate (S + FB) control variable 316
Table 17.9 Total loanable funds modifier, W/WO separate (S +
FB) control variable 317
Table 17.10 Separate (S + FB − TR – A) an (Tr + A) deficit
modifiers, with stand alone (S + FB) control variable 319
Table 17.11 Separate (S + FB − TR − A) an (Tr + A)
deficit modifiers, no stand alone (S + FB) control
variable 321
Table 18.1D Growth in explained variance when adding crowd
out to a standard model 329
Table 18.1B Base line model with only deficit variables added:
estimates of consumption crowd out 331
Table 18.1 Comparing Robustness Over Time of Effects
on Consumption of Crowd out, With and With
out Compensating Loanable Funds (Separate
Stand-Alone S + FB Variable Included) 335
Table 18.2 Changes in regression coefficients and t-statistics
associated with loanable funds changes 340
 LIST OF TABLES xxxi

Table 18.3 Effects of adding “crowd out” and “Crowd In”

Periods 342
Table 18.4 Simulated results of combining statistically significant
“Crowd In” and “crowd out” samples 344
Table 18.5 Effects of adding a separate, sand alone loanable
funds variable to a crowd out model 346
Table 18.6 Crowd out variable coefficients, t-statistics and R 2
in different sample periods* 349
Table 18.7 Annual Growth (+)/Decline (−) in Deficits
1990–2000 357
Table 18.8 Annual Growth (+)/Decline (−) in Deficits
1960–2000 359
Table 18.9 Robustness of effects of crowd out on consumption
(No Stand-Alone Loanable Funds Control Variable) 366
Table 18.10A Growth in explained variance when adding crowd
out to a standard model 371
Table 18.10 Effects on investment of crowd out,
with and without modification by loanable
funds (Stand Alone (S + FB) and GDP Variables
Included) 375
Table 18.10B Base line model with deficit variables added: estimates
of investment crowd out 379
Table 18.11 Estimates of investment of crowd out,
with and without modification by loanable funds (No
Stand Alone (S + FB); GDP variable included) 381
Table 18.12 Cptr. 18 Consumption Summary Table 386
Table 18.13 Cptr. 18 Investment Summary Table 388
Table 19.1 Regression estimates of crowd out effects using
different definitions of loanable funds crowd
out effect per $ of deficit and (t-statistic) shown 396
Table 19.2 Regression estimates of crowd out effects using
different definitions of loanable funds (Table 19.1
Models With Stand Alone M1 Variable Added) 401
Table 19.3  Investment regression results for all variables
included in the one and three variable M1 models 404
Table 19.4  Consumption regression results for all variables
included in the one M1 and three M1 models 404
Table 19.5 Summary table standard consumption model
with LF, M1 deficit modifiers 408
Table 19.6 Summary table standard investment model with LF,
M1 deficit modifiers 409
xxxii LIST OF TABLES

Table 20.1 Effects on Standard Consumption Model

of an additional separate variable,
with and without also adding it as a deficit
modifier 417
Table 20.2 Robustness over time of effects on consumption
of crowd out, with and without offsetting loanable
funds (no stand-alone modifying variables were used) 421
Table 20.3 Comparing robustness over time
of effects on investment of crowd out,
with and without accommodating loanable funds
modification 427
Table 20.4 Comparing robustness over time
of effects on investment of crowd out,
with and without loanable Funds and M1
modification (no stand-alone modifier) 429
Table 20.5 Effects on investment of crowd out,
with and without loanable funds and M1
modification (no stand-alone modifier, GDP control
added) 435
Table 20.6 Chapter 20 Consumption Summary Table 1 (S +
FB), (S + FB + M1), M1, and (M1 + FR purchases)
deficit modifier and stand-alone models 439
Table 20.7 Chapter 20 Consumption Summary Table 2 (S +
FB), (S + FB + M1), M1, and (M1 + FR purchases)
deficit modifier (no stand-alone offset) models 441
Table 20.8 Chapter 20 Investment Summary Table 3 (S + FB),
(S + FB + M1), M1, and (M1 + FR Purchases)
Deficit Modifier and Stand-Alone Models 443
Table 20.9 Chapter 20 Investment Summary Table 4 (S + FB),
(S + FB + M1), M1, and (M1 + FR Purchases)
Deficit Modifiers; (No Stand Alone, GDP Added)
Models 445
Table 21.1 Comparisons of statistical significance of M1 effects
on the prime interest rate in Keynesian and Taylor
Rule interest rate determination models 461
Table 21.2 Summary Table: Effects of Growth in M1, (Tr + A),
(M1 − r + A) on CBor , Interest Rates, and Inflation 463
Table 22.1 Effects of crowd out and loanable funds on business
borrowing (controlling for total loanable funds) 470
Table 22.2 Effects of crowd out and loanable funds
on business borrowing (controlling for endogenous
and exogenous loanable funds separately) 472
 LIST OF TABLES xxxiii

Table 22.3 Effects of business borrowing on P&E investment 475

Table 22.4 Effects of crowd out and loanable funds on consumer
borrowing 478
Table 22.5 Effects of crowd out and loanable funds on consumer
borrowing 481
Table 22.6 Effects of business borrowing on consumer
borrowing 483
Table 22.7 Effects of consumer borrowing on consumer demand 487
Table 22.8 Chapter 22 Summary Table: Effects of growth in (S
+ FB = LF), (Tr + A), (LF − Tr − A) on C Bor ,I Bor 489
Table 23.1 Effects of lagged loanable funds on inflation 494
Table 23.2 Estimated relationship of loanable funds to the M1
money supply M1 = ƒ(GDP, loanable funds) 497
Table 23.3 Effects of growth in (S + FB = LF), (Tr + A), (LF
– Tr – A) on inflation 499
Table 23.4 Summary table M1 as a function of loanable funds,
controlling only for GDP 505
Table 24.1 Comparing M1 and FR purchases as determinants
of the prime interest rate 512
Table 26.1 US banking system excess reserves (% of total
reserves) 523
Table 27.1 Explanator Power of Models With Total Loanable
Funds (LF) Variables, compared to Baseline Deficit
Model With no Loanable Funds Variable Included 534
 PART I

Introductory Chapters
 CHAPTER 1

Introduction

1.1 The Crowd Out Problem

and Accommodative Monetary Policy
John Maynard Keynes (1936) created a revolution in macroeconomics,
arguing that in periods of economic recession or depression, governments
could stimulate the economy and help restore full employment by cutting
taxes or increasing government spending.
Almost 50 years later (1983), one of Harvard’s greatest economists,
Otto Eckstein, noted with great disappointment that economists had been
arguing for decades about whether these Keynesian stimulus programs
worked, and had failed to reach any general agreement. Even more disap-
pointing, thirty-four years later after Eckstein, in 2017, this author’s own
studies indicated the continuing (and embarrassing) lack of consensus
among macroeconomists on this issue most central to the importance of
their own discipline. There clearly was a need for a science-based work
that would resolve the question once and for all.
Toward that end, in 2017, a book containing what is probably the most
exhaustive scientific study ever done of the effects of Keynesian fiscal stim-
ulus programs, and their effect on the economy, was published (Heim
2017). Its statistical testing of hundreds of models and time periods
concluded Keynesian stimulus programs:

© The Author(s), under exclusive license to Springer Nature 3

Switzerland AG 2021
J. J. Heim, Why Fiscal Stimulus Programs Fail, Volume 1,
https://doi.org/10.1007/978-3-030-65675-1_1
4 J. J. HEIM

1. Could stimulate the economy as Keynes argued, but that unfortu-

nately,
2. The stimulative effects were commonly offset by reduced private
spending due to the “crowd out” problem caused by deficits (which
Keynes never addressed).
The need to borrow money to fund the deficits created by Keyne-
sian stimulus programs reduces (“crowds out”) what is available
for consumers and businesses to borrow, reducing their spending.
This reduction has a negative effect on spending that offsets the
positive Keynesian stimulus effect on spending, leaving the stimulus
ineffective.
3. (1) and (2) left the impression Keynesian stimulus programs didn’t
work, when the truth was, they did, but were offset by crowd out, a
factor Keynes had failed to address in his analysis.

The study found overwhelming empirical proof that because of the

“crowd out” problem fiscal stimulus programs generally did not work.
Keynesian economists have long argued that the “crowd out” problem
is not fatal; that Federal Reserve “accommodative” monetary policy,
undertaken at the same time the Keynesian stimulus programs are under-
taken, eliminates the “crowd out” problem and allows stimulus programs
to work as Keynes intended. This is done by increasing the loanable
funds available for consumers and businesses to borrow to offset what
is borrowed by the government to fund the deficit.
The purpose of this book is to comprehensively test the assertion that
accommodative monetary policy can eliminate the “crowd out” problem,
allowing fiscal stimulus programs to stimulate the economy as intended. It
is intended to be the largest scale scientific test ever performed (hundreds
of separate statistical tests covering 50 years) of whether accommoda-
tive monetary policy, which increases the pool of loanable resources (or
natural growth in this pool), can offset the crowd out problem. The book,
employing the best scientific methods available to economists, concludes
it could have, but until the quantitative easing program, Federal Reserve
efforts to accommodate fiscal stimulus programs were not large enough
to offset more than 1/8 to 1/4 of any one year’s crowd out problem.
That provides the science part of the answer as to why accommodative
monetary policy didn’t accommodate; too little was tried.
There was also a monetary policy part that contributed to the Federal
Reserve’s failure to effectively accommodate. It involves flaws in the actual
methods used by the Federal Reserve as it attempts to increase bank
 1 INTRODUCTION 5

reserves, so as to replace lost borrowing power due to “crowd out,” i.e.,

enact accommodative monetary policy.

1. Federal Reserve purchases of securities were done from banks, but

the wrong type of banks (investment banks rather than commercial
and savings banks), and
2. Much of the Federal Reserves securities purchases were from foreign
banks and in some cases have increased the loanable funds pool in
foreign countries, where it was of little use in stimulating the US
economy.

The Fed mostly buys securities from investment banks and brokerages,
who sell the Fed securities mainly so they can buy other securities. Securi-
ties purchases by investment bankers do not in any direct way increase the
GDP or reduce unemployment. Fed securities purchases would have been
much more effective at restoring private borrowing lost to crowd out, if
the Fed had restricted its purchases to retail banks, i.e., commercial and
savings banks, whose main line of business is loaning to those that wished
to buy houses, cars, machines, and factories. Such purchases do increase
the GDP and lower unemployment.
Worse, many of the purchases were from foreign banks, with no guar-
antee payment by the Fed would be deposited and spent in the U.S. at
all. If not, loanable funds in the U.S. are not increased, and no offset to
the crowd out problem occurs. Hence, the fiscal stimulus does not work.
In one period sampled (2014), about 40% of all Fed purchases were from
foreign banks and brokerages.
This is Book 1 of a two-book-related series. Book 1 explores the
effect of total loanable funds and M1 on the economy. The second book,
Why Fiscal Stimulus Programs Fail, Volume 2: Statistical Tests Comparing
Monetary Policy and Growth Effects is more science oriented and less
policy analysis oriented. It contains nine additional econometric chap-
ters and less policy analysis chapters. The nine econometric new chapters
focus on testing the exogenous part of loanable funds generated by
Federal Reserve securities purchases and the endogenous part generated
by economic growths causing a natural growth in saving. The objective
is to determine which of these two parts of total loanable funds is the
most effective in reducing crowd out’s negative effect on consumer and
business spending.
6 J. J. HEIM

1.2 Individual Chapter Contents and Findings

A summary of how these science and policy issues are examined in the
remaining chapters of this study is presented below, as are the findings of
each chapter.
In Chapter 2, we look at previous literature on the subject. We find that
the business press nearly unanimously agrees that FR security purchases
during the quantitative easing period helped Wall Street, the bond and
stock markets, by pushing up stock and bond prices, but did not much
affect Main Street, i.e., the GDP and unemployment. The academic and
professional literature agreed QE had a positive effect on Wall Street stock
and bond market prices, but was split on whether there was any positive
effect on the GDP and unemployment to go along with it.
Chapter 3 discusses the methodology used in this study. The models
tested are fairly standard models of consumption and investment’s deter-
minants (income, interest rates, profits, etc.), with deficit variables added
to measure crowd out effects, and either loanable funds, M1 or M2 vari-
ables added to measure accommodative monetary policy. Well over 1000
tests of specific consumption and investment models and time periods
were undertaken in volume I and II of this book.
Initial findings for any model are tested in multiple time periods
to ensure results are replicable. The importance of replication in any
economic study (preferably before publication, so as not to waste the
reader’s time reading spurious results), is discussed.
Techniques used to control for typical time series regression problems
are discussed, including stationarity, endogeneity, multicollinearity, serial
correlation and heteroskedasticity. Particular difficulties obtaining signifi-
cant results when mixing data from “crowd out” and “crowd in” periods,
or mixing periods in which there is no movement in key deficit variables
with periods in which there is, are discussed. Guidelines for acceptable
percentages of the data being of one category or the other are suggested.
Circumstances under which creating a loanable funds-modified deficit
variable is an appropriate way of modeling the effectiveness of changes
in loanable funds in reducing crowd out are discussed, as well as circum-
stances in which a stand-alone variable representing loanable funds should
also be used. In short, in consumption models, an increase in loan-
able funds has two effects: a positive crowd out effect and a negative
effect stemming from the ceteris paribus (partial derivative) nature of
the process of estimating marginal effects using regression; that is,
 1 INTRODUCTION 7

it measures the effect of an increase in loanable funds on consumption

holding income and other variables in the model (taxes, government
spending, etc.) constant. That being so, an increase in savings, i.e., loan-
able funds, can only occur if there is a reduction in consumption. Two
separate effects require two separate variables if one is to see each effect
separately.
Chapters 4–6 present the theory of how crowd out occurs when
budget deficits occur, how crowd out negatively affects the GDP, and how
changes in M1 or loanable funds can offset it. Chapter 4 presents the basic
theory in both literary and mathematical form; Chapter 5 presents the
same theory in balance sheet form. Chapter 6 presents the same theory
in money multiplier form.
Chapters 7–9 of this study examine the Federal Reserve’s (FR) use
of accommodative monetary policy. Chapter 7 examines whether using
investment banks, brokerages, and foreign banks reduces the effective-
ness of accommodative monetary policy (compared to using only U.S.
commercial and savings banks), and concludes it does. Test results
showing this are presented. Chapter 8 examines the success of accom-
modate monetary policy before and after the quantitative easing program
was introduced. Data is presented to show it was a failure 1960–2007,
but successful after that due to the huge size of the accommodation
program after the QE program started in 2008. This chapter also exam-
ines the “pushing on a string” problem that developed in the QE era. This
problem limits of the FR’s ability to stimulate the economy when loan-
able funds are increased far in excess of the current demand for loans.
It concludes large increases in reserves created by the FR during the
QE period went unused because of insufficient demand, something tied
strongly to the overall size of the economy.
Chapter 9 shows that FR purchases of securities are not always matched
by an equal increase in loanable funds in U.S banks; it often is less. The
best explanation for this is that the FR buys substantial amounts of securi-
ties from foreign banks, increasing the loanable funds available in foreign
countries, but not increasing loanable funds in the U.S.
Also examined are the effects of Federal Reserve (FR) security
purchases on M1 growth and on the GDP (Chapters 10–11). Chapter 10
statistically examines the relationship of FR security purchases to M1
growth and finds a strong relationship. Chapter 11 examines the effect of
M1 and loanable funds availability on GDP and concludes FR purchases
have a positive effect, and that the effect if felt mainly through changes
8 J. J. HEIM

M1’s effect on housing investment and 2 years later, changes in demand

for consumer services.
Effects of FR Security Purchases on Stock, and Bond Prices
Chapter 12 examines the effect of FR security purchases on stock and
credit market prices and always finds a strong positive relationship with
bond market prices, but never with stock market prices except for the
enormous increase in FR security purchases during the QE years.
Estimating Crowd Out’s Actual Effects
Chapter 13 tests to determine if the crowd out problem actually
occurs. It does. Chapter 14 extends the initial tests in Chapter 13 to
different time period to ensure initial results were worthy of publishing,
i.e., could be replicated in other time periods and models. The goal was
to create results, so persuasive analysts would no need for further studies
in this area.
Total Loanable Funds as a Crowd Out Modifier
Several chapters statistically test to demonstrate how effectively growth
in the total pool of loanable funds can offset crowd out (Chapters 15–
18). Chapter 15 develops the methodology to test the extent to which
the negative effects of crowd out can be offset by changes in the size
of the loanable funds pool. It concludes that the increase in loanable
funds is large enough, it can completely offset crowd out. Chapter 16
tests different ways of modeling the combined effects of deficits and
loanable funds offsets, either as one “modified” deficit variable or as
separate deficit and loanable funds variables. As was noted earlier in
discussing methodology, for consumption models, modifying the deficit
variable and including a stand-alone modifier variable are the best, but
that just including a stand-alone variable produced the same net results
and therefore is an equivalent alternative. For investment, just the deficit
modifier may be enough. Chapters 17 and 18 verify that Chapter 15
results can be (and were) replicated in multiple time periods and models.
M1 as a Crowd Out Modifier
Chapter 19 determines whether M1 or loanable funds best explain how
crowd out is offset, and concludes total loanable funds are the better
measure.
Chapters 20 tests additional M1 models. It examines whether the
deficit, modified by growth in M1, is a more accurate measure of how
much crowd out effects can be modified than deficits modified by changes
 1 INTRODUCTION 9

in total LF. Total LF was found to be a better measure of how much

crowd out can be offset than M1.
LF Effects on Consumption and Investment Indirectly through Their
Structural Determinants
Tests described above in Chapters 10–21 test LF or M1 variables by
just adding them to the model as new separate variables or by using them
to modify the deficit, or both. No structural mechanism is specified for
how they bring about a change in consumption or investment; they are
“black box” models, in the sense used to describe money’s effect on the
GDP in the St. Louis Equation decades ago. Chapters 22–24 attempt
to correct this. They test the hypotheses that the change in loanable
funds directly affects borrowing, inflation, and interest rates, all of which
subsequently are determinants of consumption and investment.
Chapter 22 tests the relationship of consumer and business borrowing
to changes in total loanable funds (LF) and finds changes in LF signifi-
cantly, positively effect business borrowing. Changes in the endogenous
portion of LF were the most important. Total loanable funds are posi-
tively related to borrowing, but neither part alone was consistently
significant.
Chapter 23 tests the relationship of inflation to changes in M1 and
LF in Phillips curve inflation models. M1 was found significantly related
to inflation, but not LF or either of its two components, even though
we show changes in LF are positively related to changes in M1. The lack
of relationship appears to be an econometric problem related to adding
variances, not a substantive finding. Evidence indicated M1 was mostly
driven by changes in the exogenous part (FR purchases) of LF, but less
systematically to growth in the endogenous part.
Chapter 24 examines the relationship of the Prime interest rate to vari-
ation in M1. In Taylor Rule models, M1 was not significant in most
periods sampled. But it may be because the inflation variable in Taylor
models is already affected by M1; hence, adding it separately may be
redundant, and the reason it found is insignificant.
We show that even though LF and M1 are significantly related, and
M1 and the Prime rate are also significantly related, it is possible that
the regression of LF on the Prime rate will be insignificant because both
relationships, though significant, have low R 2 s, but that doesn’t mean
they are not linked.
By comparison, Keynesian models show significant liquidity effects
and, after a lag, inflation effects of a change in M1 on interest rates are
10 J. J. HEIM

found in all time periods sampled. The same was true for total LF and its
two parts.
Chapters 25–29 summarize the results of all earlier chapters.
Chapter 25 summarizes the introductory, literature, and methodology
Chapters (1–3). Chapter 26 summarizes the theory Chapters (4–6)
and the Chapters (7–9) analyze the mechanics of implementing accom-
modative monetary policy, and how successful it has been. Chapter 27
summarizes the tests undertaken to determine if crowd out exits, and if so,
how best to scientifically measure the extent to which changes in loanable
funds, or reasonable variants of them, can offset it and which appear to
work best (Chapters 10–24). Chapter 28 summarizes the equations found
reliable enough to be considered engineering equations, available for reli-
able use by policymakers and analysts. Chapter 29 provides definitions for
the multitude of acronyms used in the book.

1.3 Summary of Key Findings

To conclude this introduction, let us briefly summarize the book’s major
findings, taken from Chapter 30.
Even in the summary form presented in Chapters 25–27, this book’s
findings are highly detailed, and it can be difficult to tell the forest from
the trees. To summarize this book’s major findings in as a brief way
as possible (a summary of summaries), we repeat the major empirical
findings of this book here:,

1. Deficit-driven fiscal stimulus programs positively stimulate the

economy, but simultaneously create negative “crowd out” problems
related to financing the deficit out of the existing pool of loanable
funds. Financing the deficit reduces private borrowing, and there-
fore spending, out of the pool. The combined effects of stimulus
and crowd out usually leave fiscal stimulus programs having a zero
or near-zero net effect.
2. If the pool of loanable funds grows sufficiently, which is policy
controllable by the Federal Reserve, it can offset negative crowd
out completely, leaving fiscal stimulus programs effective. There is
considerable evidence this occurred during the quantitative easing
(QE) period, but not before.
 1 INTRODUCTION 11

3. Total loanable funds are a better measure of the actual crowd out
modifying effect than either its endogenous part or its exogenous
part (FR security purchases) alone, though the endogenous part
explains most of the variation that total loanable funds do. Total
loanable funds, as a deficit modifier, also explain more variation in
consumption and investment than M1.
4. While the level of loanable funds is policy controllable by the Federal
Reserve, it is not likely that its current methods of exercising this
control through investment banks have much positive effect on the
GDP or lowering unemployment.
The Federal Reserve historically has relied on purchasing secu-
rities from investment banks and brokerages. These institutions
typically only sell securities to the Fed (or anybody else) to obtain
funds to buy other securities. Securities trading is what they do for
a living. This helps inflate bond market prices, helping Wall Street.
The Federal Reserve, historically, has relied on purchasing securities
from investment banks and brokerages. Such institutions most typi-
cally only sell securities to the Fed (or anybody else) to obtain funds
to buy other securities. After all, securities trading is what they do for
a living. This helps inflate bond market prices, helping Wall Street,
but does little to increase the demand for real goods and services
necessary to raise GDP and lower unemployment, which is what is
needed if Federal Reserve actions are to help Main Street.
If this hypothesis is correct, the results should indicate a smaller
marginal effect on consumption and investment of a dollar’s increase
in loanable funds due to FR security purchases than by a dollar’s
increase due to growth in the endogenous portion of the loanable
funds pool. And this is exactly what we see. For consumption, in
6 of 6 periods tested, the estimated marginal effect is lower for
increases in FR purchases than for increases in the endogenous part
of the loanable funds pool. For investment, the marginal effect of
an increase in loanable funds is lower for FR purchases compared
to endogenous growth in 5 of 6 periods tested (Chapter 17,
Tables 17.5 and 17.6).
The Federal Reserve’s purchases of securities would more likely
stimulate the GDP and reduce unemployment if its purchases of
securities were restricted to purchases from U.S. commercial and
12 J. J. HEIM

savings banks. It is these banks, not investment banks and broker-

ages, that are in the business of directly lending money to consumers
and businesses that want to buy, cars, houses, machinery, and other
goods and services, the very actions which will raise GDP and reduce
unemployment.
5. In addition, many of the investment banks used are foreign banks
with less incentive to invest Federal Reserve money in the U.S. than
U.S. banks would have.
6. Finally, here is a major policy issue involved in deciding what to
do with any growth in loanable funds that occur, whether by
endogenous or exogenous means.
With no deficit, growth in the loanable funds pool, if borrowed,
increases the GDP by increasing private investment and spending.
With a deficit created by a fiscal stimulus program, the increase in
loanable funds goes to offset crowd out effects (i.e., keep private
spending at old levels). The increase in GDP due to the fiscal stim-
ulus is likely to be more oriented toward production of public goods
than the no-deficit increase in private spending characterizing that
leads to that increase in GDP. Hence doing deficits amounts to
policy decision about private vs public goods.

References
Eckstein, O. (1983). The DRI Model of the U.S. Economy. New York: McGraw-
Hill Book Company.
Heim, J. J. (2017). Crowding Out Fiscal Stimulus. Hoboken: Palgrave
Macmillan.
Keynes, J. M. (1936). The General Theory of Employment, Interest and Money.
London: Macmillan.
 CHAPTER 2

Literature Review

This literature review is based on an exhaustive survey of recent literature

on the effect of accommodative monetary policy on:

1. The stock and bond markets,

2. The GDP, and
3. Inequality.

Findings are presented in two sections: first, in a summary of findings

from the literature reviewed, and second, in a larger, more detailed form,
for those who wish to investigate the literature more thoroughly. The
more detailed review includes each author’s own statement of their find-
ings and how to interpret them, as well as a description of each study’s
methodology.

2.1 Summary of Findings

The business press concludes the main beneficiaries of the quantitative
easing (QE) program have been the owners of stocks and bonds, who
have seen the prices of those assets rise dramatically due to QE, and
that this has increased inequality (see, for example, Warsh, K., former FR
Board member, WSJ, August 24, 2016).

© The Author(s), under exclusive license to Springer Nature 13

Switzerland AG 2021
J. J. Heim, Why Fiscal Stimulus Programs Fail, Volume 1,
https://doi.org/10.1007/978-3-030-65675-1_2
14 J. J. HEIM

The business press was also virtually unanimous in assessing the Fed’s
attempts to raise GDP and lower unemployment using QE to stimulate
the economy, were a failure.
Professional and academic press studies tend to find monetary policy
has had a positive effect on both the stock and bond markets, and GDP.
This is particularly true since the beginning of the QE period in 2008.

2.1.1 Stocks and Bonds

All studies of the effects of the huge increases in FR security purchases
during the QE program, without exception, in the business press and
academic/professional papers reviewed, found that bond interest rates
were lowered (bond market prices increased). A one trillion USD
purchase of long-term bonds reduced 10-year U.S. Treasury yields and
low-grade corporates by about 30 to 50 basis points while MBS yields
declined by 66 basis points and mortgage rates fell further still…. (Krish-
namurthy and Vissing-Jorgensen 2011). 1 trillion in bond purchases by
Fed reduced treasury and corporate bond rates 0.3–0.5%; MBS rates
declined by 0.66% (Krishnamurthy and Vissing-Jorgensen 2011). Bond
purchases equal to 10% of GDP lowered interest rates on an average of
0.68% in 28 studies reviewed (Gagnon 2016). Mortgage rate dropped
1.3% (Caixa Bank Research 2018), Klein and Evans (1968), Eckstein
(1983). Fair (2004) and Heim (2017) found the same result for bond
and mortgage markets, but did not test for stock market effects.
Federal Reserve security purchases effectively funded 55% of treasury
debt issued during the Obama presidency, compared to 10% during World
War II (Gramm and Saving 2017). Bank reserves have grown as a result of
quantitative easing to 13.07 for every dollar they are required to hold and
have not expanded bank lending (Gramm and Saving 2017), indicating
a “pushing on a string” effect of FR purchases increases during the QE
period.

2.1.2 GDP
Most professional/academic papers reviewed found stimulative mone-
tary policy has positive effects on GDP or in reducing unemployment.
Some papers also found a positive effect on inflation. Only 3 found no
effect on GDP of QE or earlier efforts by the Fed to increase asset
 2 LITERATURE REVIEW 15

purchases through open market operations. (Business Press articles consis-

tently concluded just the opposite: massive FR security purchases during
the QE period had no effect on the GDP or unemployment.) A summary
of professional literature findings indicates:

QE: 0% effect on inflation or economic growth (Williamson 2017).

QE lowered unemployment rate 1% …(Wu and Xia 2016). $40
billion in asset purchases increases output 0.4% Bhattarai et al.
(2015). Asset purchase equal to 1% of GDP raises GDP 0.58%
Weale and Wiedelak (2016). A$600 billion increase in asset
purchases increases GDP 0.13% (Chen et al. 2012). Doubling
the size of FR balance sheet increases GDP by 0.45% for QE2
and 0.12% for QE3 (Bhattarai et al. 2015). QE1 was estimated
to raise GDP 1.0%. Accommodating monetary policy had a posi-
tive effect on GDP, but of negligible size: only 0.4% of the
size of the combined fiscal and monetary stimulus itself (Heim
2017), Klein and Evans (1968), Eckstein (1983). Fair (2004)
also found the same result for effect of monetary policy on GDP.

Long-term multiplier effects of monetary policy have been small (0.1–

0.4) (Leeper et al. 2017). Multiplier is 1.5 when monetary policy is at the
zero lower bound (ZLB), less above it (Wataru et al. 2018). The output
multiplier is 0.5–1.9, depending on the shadow interest rate (Wataru et al.
2018).
Conclude: The professional/academic literature concludes Federal
Reserve asset purchases between $40 billion and roughly $1 trillion
increased GDP from near 0.00% to 0.58%, with no correlation of study
results with purchase size. Multiplier results were similarly mixed, with
multiplier effects of monetary stimulus generally varying from 0.5 to 1.9.
Business Press articles consistently concluded just the opposite: they
found that massive FR security purchases during the QE period had no
effect on the GDP.

2.1.3 Inequality
Summary of Effects: All three professional press studies surveyed found
changes in monetary policy increased inequality. However, the results
of one study indicated contractionary monetary policy changes did
16 J. J. HEIM

it, while the other two said expansionary monetary policies increased
inequality. Business press reports found FR security purchase programs
(QE) increased inequality.

2.2 Detailed Findings

2.2.1 Assessment of Monetary Policy
Effectiveness in the Business Press
It is commonly asserted in the business press that when the FR adopts a
stimulative monetary policy, i.e., purchases securities in the open market,
primarily, it results in a financial markets gain, but not a real economy
gains, as noted in the quotes below.

Stock Market Effects

…The Federal Reserve’s main ministration for a weak recovery, after all
has been stoking a “wealth effect”. By levitating the stock portfolios of
the top 1%, jobs and wage growth for the other 99% would be stimulated.
“Higher stock prices will boost consumer wealth and help increase confi-
dence” once explained ex-Fed chief Ben Bernanke. It hasn’t worked. The
only confidence simulated has been the confidence of hedge funds that
stocks might be a good bet in the short term if central banks are printing
money…. (Jenkins, H., WSJ, November 7, 2014)

and

…Easy money is driving up the prices of stocks, bonds, houses…central

banks are unleashing easy money to fight an imaginary villain, consumer
price deflation, at the risk of feeding a real monster, asset price inflation….
(Sharma, R., WSJ, May 12, 2015)

and

…Since the Fed began aggressive monetary easing in 2008,…nearly 60%

of stock market gains have come on those days, once every six weeks, that
the Federal Open Market Committee announces its decisions…Mr. Trump
was basically right in saying that Fed policy has done more to boost the
prices of financial assets-including stocks, bonds and housing-than it has
done to help the economy overall…Much of the Fed’s easy money has
gone into financial engineering, as companies borrow billions of dollars
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