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This is the crux of the "pushing on a string" metaphor — that money cannot be pushed from the central bank to borrowers if they do not wish to borrow. Alternatively, the process can be seen as borrowers demanding credit from commercial banks, who then borrow base money to provide reserves to back the new bank money : demand for credit pulls base money from central banks.

This presentation is particularly associated with, and seen as support for, endogenous money theory, such as monetary circuit theory , in that money supply is not determined by an exogenous external force central bank policy , but rather a combination of central bank policy and endogenous internal business reasons.

Commercial banks extend loans, and borrowers take out loans, for commercial reasons — because they expect to benefit from them: banks profit by charging interest on the loan higher than they must pay on their debts the "spread" , while borrowers may for instance invest the money hire workers, build a factory , speculate with it, or use it for consumption. These loans must in turn be backed by reserves — this is a legal requirement, otherwise banks could print unlimited quantities of money — and banks are allowed to extend as loans some multiple of reserves: in a fractional-reserve banking system banks are allowed to extend more loans than they have reserves the ratio is called the money multiplier , and is greater than 1 , while in a full-reserve banking loans must be precisely backed by reserves and the money multiplier is 1.

The distinction between fractional-reserve and full-reserve is not significant in this context — the important point is that in both systems, loans must be backed by reserves. Crucially, central banks can limit money creation by either limiting the amount of base money extended, thus denying reserves and preventing commercial banks from extending further loans, or by raising the price of base money extended by increasing interest rates and thus making loans less profitable for the bank raising the hurdle rate , and while relaxing these constraints can encourage money creation, central banks cannot force commercial banks to extend credit — monetary policy can pull but not push.

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By increasing the volume of their government securities and loans and by lowering Member Bank legal reserve requirements, the Reserve Banks can encourage an increase in the supply of money and bank deposits. They can encourage but, without taking drastic action, they cannot compel. For in the middle of a deep depression just when we want Reserve policy to be most effective, the Member Banks are likely to be timid about buying new investments or making loans.

If the Reserve authorities buy government bonds in the open market and thereby swell bank reserves, the banks will not put these funds to work but will simply hold reserves. Result: no 5 for 1, "no nothing," simply a substitution on the bank's balance sheet of idle cash for old government bonds. If there is unmet demand for credit money, then credit money is pulling and monetary policy can be effective, by being more or less restrictive, just as if a dog or horse is pulling on a leash or bridle its speed can be regulated by reining it in or letting it loose — one says that the reserve requirement constraint is binding.

If, conversely, all demand for credit money is being met, either because banks do not wish to lend finding it too risky or unprofitable or borrowers do not wish to borrow having no use for added debt, such as due to lack of business opportunities , then the string is slack, the reserve constraint is not binding, and monetary policy is ineffective: monetary policy allows reining in a horse, but does not allow whipping it on.

The breakdown in monetary policy is particularly damaging because it often occurs in financial crises such as the Great Depression and the Financial crisis of — : in the midst of a crisis, banks will be more cautious about lending money due to higher risk of default, and borrowers will be more cautious about borrowing money because of lack of investment and speculation opportunities: if demand is dropping, new investment is unlikely to be profitable, and if asset prices are dropping following the bursting of a speculative bubble , speculation on rising asset prices is unlikely to prove profitable.

Restated, increases in central bank money may not result in commercial bank money because the money is not required to be lent out — it may instead result in a growth of unlent reserves excess reserves. If banks maintain low levels of excess reserves, as they did in the US from to August , then central banks can finely control broad commercial bank money supply by controlling central bank money creation, as the multiplier gives a direct and fixed connection between these.

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