I have tried to show, with this presentation, evidence of the points that I listed in the objectives at the beginning:

1. A fractional reserve banking system allows banks to increase the quantity of money, independent of any central bank (e.g. The Federal Reserve)

Before The Fed comes on the scene we see banks "creating" money in Fractional Reserve Banking in Action.

Even after the creation of The Fed we see three examples of banks "creating" money without the involvement of The Fed: Banks Creating More New Money, Banks Create Even More New Money, and Banks Create More Money Again.

2. The Fed does not control the quantity of money, it simply influences it.

These examples work in tandem with those above to demonstrate that The Fed does not control the quantity of money. In the first case, actions by The Fed do shrink the deposit capacity of The Banks: Banks Deposit Capacity Reduced.

The next examples demonstrate how The Fed cannot force monetary growth, it only sets the limits. See Deposit Capacity Increased by Reduced Reserve Requirement, and Deposit Capacity Increased by Securities Sale. In each of these cases actions by The Fed increase the amount of excess reserves, but The Banks do not buy notes (make loans) and increase deposits (or money) in direct response.

The Fed has the greatest influence on the expansion of the quantity of money when it buys securities from non-banks. In Fed Buys Securities from Non-Bank I show how, when The Fed buys securities from non-banks, The Banks have the obligation to increase their deposit liabilities (a form of money) to the sellers.

In one situation—a severe contraction in the amount of reserves (not depicted here)—The Fed's influence comes close to control. If The Fed took some action (either increasing reserve requirements or selling securities, which buyers acquire without coercion) that left the entire banking system with a reserve deficit (i.e. negative excess reserves), banks would have to act to restore required reserve balances. The most likely action would consist of calling loans. Loan payoffs would reduce loan balances and deposit liabilities (and money) an equivalent amount.

This form of money deflation would cause economic havoc because it would draw money capital from the markets, force borrowers to sell assets to acquire that money, and send false signals of excess inventories.

3. Bank reserves (created by The Fed) never enter the general economy, thus do not qualify as money.

A simple model like this makes this point a little difficult to demonstrate. First, follow the transactions of The Banks after gold transfer. You will see, as I point out in this comment on the page titled Fed Liabilities Replace Gold as Reserves, that banks cannot trade the asset they list as "Reserves". Second, if you continue to doubt, ask your banker if you can buy some "Bank Reserves" or if you can get a check drawn on The Fed. I have attempted to demonstrate this point by using different ounce units (M-oz. and R-oz.) and by different colors for gold, "Bank Reserves" at The Banks, and "Deposit Liabilities (Reserves) at The Fed.

In the current banking structure actions by The Fed only affect bank reserves. Because bank reserves never enter the general economy The Fed cannot unilaterally create new money. Since only banks and The Fed transact business with "reserve dollars," they do not meet our definition of money.