Economics Credit Creation Query

Have children.

Now there's credit creation.

forget that lol! more like credit elimination

Search for "money creation"

Well, that is actually an interesting question.

For those unfamiliar with the term, high-powered money refers to new bank reserves created by a nation's central bank; high powered because in fractional reserve systems (where banks only need to keep reserves equal to a fraction of total deposits) the central bank created reserves allow the money supply to be increased by a substantial multiple of the reserve amounts.

As an aside, fractional reserve banking systems are why "bank runs" can collapse financial systems: banks don't keep enough reserves to pay all depositors at once should they panic and attempt to withdraw all their deposits en masse.

It is also why, even before the gold standard was suspended by FDR, deposit money at banks far exceeded the banks' gold reserves. Thus the idea of hard money was even then a delusion.

To go back to the question, here is an alternative theory:

Because central banks generally oblige themselves to support as much actual paper money as the public wants to hold (converting demand deposits to currency in circulation as they choose); and because non-bank financial institutions can create dollar denominated assets without the involvement of the central bank (e.g. investment funds that bid up the notional price of abstract investment products like derivatives); and because these assets may make their way directly or indirectly into commercial transactions; then the central bank is given the choice whether to create a liquidity crisis or to accommodate continued functionality in the banking system by allowing the tail to wag the dog, and follow the lead originating from outside itself.

Might this not even explain the need for a massive, apparently vast injection of "excess" liquidity by the Federal Reserve into the banking system in response to the credit crisis? Why so much extra, relative to bank deposits, even though bank loans are in short supply (and not even much in demand in a slow economy held back by weak consumer spending)?