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for making this question clear let's create a simplified world when there are only 3 private banks (bank A, bank B, bank C) in the world, and 1 central bank. let's also assume that all the citizen in this simplified world have all their money saved in those 3 banks.

let's also assume each bank has this capital inside:

bank A : 50k dollars

bank B : 30k dollars

bank C : 70k dollars

now let's assume bank B ask for a loan to the central bank of 20k with an intrest rate of 0.7%.

logically bank B can only take money weather from bank A or C to pay back the loan to the central bank. and so it does.

but this takes the money out of the system, and back to the central bank with that 0.7% more.

now let's repeat this process over and over again, it will reach to a point where there will be no more money on the system..then what happens?

the central bank prints more money and make another loan to pay back the other loan?..

and over and over again?

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  • $\begingroup$ So essentially your questions are "1. does a single central bank loan with positive interest rate decrease money supply in the long-run?" and "2. If the answer to 1. is Yes, how does the money supply not contract?", right? $\endgroup$
    – Giskard
    Jul 2, 2022 at 8:02
  • $\begingroup$ @Andrew Nic: your case might be a little oversimplified. I think you need to consider both sides of the balance sheet to investigate this properly. that is you need track both, flows of assets and liabilities. Also, when you say "capital" do you actually mean the size of the balance sheet or really bank capital? These are two different things. $\endgroup$
    – BrsG
    Jul 7, 2022 at 15:15

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but this takes the money out of the system, and back to the central bank with that 0.7% more

It does not take money out of a system with "0.7% more". Central bank sends all net profits to the government. Hence central bank will either spend that money on its cost of operation (which means the money will circulate more as people spend it) or it will be send to the government and it will circulate further when government spends it. Hence the money supply only contracts by the amount of the money created by the loan (here I mean all money derived by the loan in case the money was previously lent further) not by the amount interest.

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