M0 are notes (e.g. dollar bills in the US) and coins Held by the public. It seems likely that almost all the notes and coins come from the public withdrawing them from banks.
Banks get the notes and coins via exchanging settlement balances at the Federal Reserve (“reserves”) for them, which are put in vaults for distribution.
The only alternative is for the Federal government to directly pay out notes and coins, which is possible, but this does not appear to be common practice.
If we ignore that alternative creation mechanism, we can answer your questions.
Firstly, an increase of M0 is reliant on the public withdrawing notes and coins from a bank. This is only possible if the bank has notes and coins in its vault, so this process is limited. In order to be sustained, the vaults need to be replenished.
- Yes, banks need to exchange reserves for notes and coins.
- A bank could borrow reserves from another bank or at the discount window to get vault cash, but those are two transactions.
- Settlement balances are destroyed when exchanged for notes and couns.