Lend out IOU: A Model of Money Creation by Banks and Central Banking

This paper considers the efficiency of money creation by banks and the principles of the central bank issuance to improve over it. The ability to issue deposit liability as a means of payment enlarges banks lending capacities and subjects them to fiercer competition. In curcumstances where banks issue too much money, interest-rate policy may help. In circumstances of a credit crunch, quantitative- easing policy helps, under which the central bank lends its issues to all banks. These issues are unbacked by taxation and purely nominal. The optimal quantity of the central bank's lending is unique and implements the first-best allocation.