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I chanced upon a good article in which the author attempts to explain why
banks are not free to create money willy-nilly. They are subject to restraints imposed by both the markets and regulators. But under current procedures, these restraints do not arise from a hard limit on the amount of reserves in the system. They arise from the costs of lending, which is conditioned by (a) the interest rate targeted by the Fed, (b) regulatory and market capital requirements and the market price for bank capital, (c) by back-office administrative and hedging costs of lending, and (d) the credit-worthiness and credit-hungriness of borrowers.
The source.
Is it not funny, in digging ever deeper into a theory — in this case Modern Monetary Theory — not rarely do I find myself incapable of finding the answers to elementary questions. The reason for this sort of haplessness is often that one is making assumptions that are not warranted.
I suspect, years ago when I briefly I had no answer to the question why banks do not issue money infinitely because I had overlooked
(1) point (d) above (the demand side) — the need for "credit-worthiness and credit-hungriness" — and
(2) the fact that from the availability of an infinite supply it does not follow that the supply will be used partly or in full.
To all intents and purposes, John has an infinite supply of insults in his head which he would love to level at his boss, but never in his life would he dare insult him.
Why not? The cost of doing so is too high.
There are costs associated with every new loan a bank is making. While the bank could make an infinity of loans (assuming an infinity of worthwhile loan applicants), each loan is costly and yields only a finite return, which ought to be larger than the cost of the loan, for the latter to be extended in the first place.
In short: if there is no infinite supply of cost-covering loans, the banks are not able to create (credit) money ad infinitum.
PS
Incidentally, at this very moment, I could not tell you what keeps banks from simply creating anew whatever money they need, to pay for expenses or finance investments.
Can you figure out the answer?
I suspect, years ago when I briefly I had no answer to the question why banks do not issue money infinitely because I had overlooked
(1) point (d) above (the demand side) — the need for "credit-worthiness and credit-hungriness" — and
(2) the fact that from the availability of an infinite supply it does not follow that the supply will be used partly or in full.
To all intents and purposes, John has an infinite supply of insults in his head which he would love to level at his boss, but never in his life would he dare insult him.
Why not? The cost of doing so is too high.
There are costs associated with every new loan a bank is making. While the bank could make an infinity of loans (assuming an infinity of worthwhile loan applicants), each loan is costly and yields only a finite return, which ought to be larger than the cost of the loan, for the latter to be extended in the first place.
In short: if there is no infinite supply of cost-covering loans, the banks are not able to create (credit) money ad infinitum.
PS
Incidentally, at this very moment, I could not tell you what keeps banks from simply creating anew whatever money they need, to pay for expenses or finance investments.
Can you figure out the answer?
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