Why can't banks print infinite money by running up huge debts at the secondary discount window rate?

Question

Banks in financial trouble can borrow from the Fed at 1% interest. Would anything stop a bank from borrowing $1M every year plus the interest on all prior debt? Since their ability to make interest payments would be based solely on whether or not the Fed kept lending, and since the Fed will not run out of money, does the Fed have any reason to stop that from happening?

Answer 1

1. If bank would only borrow money it would just create cost for the bank since they have to pay interest on the money they borrow. Hence it only makes sense for them to borrow more money from Fed if they face demand for loans. Demand for loans that business has depends on what sort of return business expects from investing that money. Eventually marginal product of capital has to decline if investment is too high keeping other factors as technology constant. As a consequence, at some point nobody would want to borrow from bank at an interest at which bank can make profit by lending the money they borrow from central bank. Because of declining marginal product of capital, there will eventually be some point where any investment would bring less return than the interest rate the bank has to pay to the central bank.

2. Too much money in the system would eventually lead to inflation forcing central bank to raise the rate, making the borrowing more expensive and again there will be point where borrowing more is not profitable for the bank. At some point the central bank might even decide to discourage borrowing from it. For example, in the past there used to be stigma to using Fed discount window. There is no reason why central banks could not go back to a regime where there aren't excess reserves.

Furthermore, post 2008 banks are heavily regulated. Because of regulation such as Basel III they can't just lend willy-nilly and consequently they won't always be even able to issue more loans even if they could in principle profitabily do so in the absence of the regulation. So this is another factor that indirectly limits how much it makes sense for them to borrow from central banks.