Excuse me, but you cannot continue to expand M1-3 without first increasing M0. It's the steady increase in M0 that's the root cause of inflation, not M1-3.
Really? Then explain why the Fed and the Treasury had to dream up TARP and a host of other insane schemes...
Because in a short period of time, banks and financial institutions were hit by massive amounts of losses on loans and derivative instruments and had to scale back lending...? And for some financial institutions with debt obligations, they needed liquidity to remain being a going concern and meet liability payments. You didn't know banks are allowed to securitize loans and remove them from balance sheet, freeing them up to make more loans? In Obama's new plan, I believe they're going to have to hold onto at least 5% of a loan that is securitized though. Edit: And to jprad -- you do not need increases in M0 for M1-3 to increase, that's the point I've been making. Banks magically create "credit" out of thin air (sure, it may or may not be based on deposits which are part of M0 initially). This credit has essentially the same characteristics of money and circulates around the economy and can be converted into M0 at any given moment in time. Eventually, this credit winds up in the savings account at a bank, and then banks can then magically create credit based on this new deposit.
I feel compelled to respond to the OP, as I think there's something being missed in this discussion. Firstly, isn't this an old and tired debate that's been going on for a long(ish) time now? I could re-iterate the theoretical arguments put forth by the proponents of fractional reserve lending, but I am sure they're well known. Instead, I would like to point out that, at least to me, it's not a question of what's better (personally, I don't see anything wrong with moderate inflation). In fact, the whole discussion of what's better is a red herring. Societies arnd the world have adopted fractional reserve lending, because humans are designed to seek gain by wanting to own yield-bearing instruments. As long as we seek to earn excess returns, fractional reserve lending will exist, in one form or another. That's how it came into existence, in the first place. In fact. even societies that prohibit yield-bearing instruments on religious grounds (Islam) have run into issues implementing full reserve banking in a way that's consistent with private ownership of commercial banks. So what exactly is the point of arguing the hypothetical merits of an imaginary and impractical system against the (well-known) imperfections of the only system that seems to suit humanity (so far)? Maybe if you were considering ways to improve the fractional reserve lending framework that's currently in place in the US mkt (Danish mtge mkt is being suggested now as a case study), I could see the point. Then it becomes a question of how to improve our understanding of monetary policy and ways to give the Central Bank more levers to regulate and control the system. But railing against the notion of fractional reserve lending itself is a waste of time, in my view.