In fractional reserve banking a bank can buy m0 and use it to create any amount of m1/m2. Why don't they do this? The loans could be just banks lending each other at 0% interest to create unlimited money.

  • $\begingroup$ You could tell yourself that you've given yourself a loan of 1 trillion dollars at 0%. Congratulations. You now have an asset of 1 trillion dollars, and a matching liability. What have you achieved, though, by doing so? $\endgroup$
    – 410 gone
    Oct 18 '18 at 10:07

In fractional reserve banking, banks need balances at the central bank (reserves), not “M0”, (which includes currency in circulation as well, e.g. dollar bills). Banks do borrow reserves, but that means that the lending bank has to give some up - the total amount of reserves is unchanged.

Although a bank can borrow reserves, its lending capacity is limited by equity requirements. People are not going to inject equity into a bank so that it can make loans without profits from the net interest margin.


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