Senior staff at the International Monetary Fund have explained in recent years that the loanable funds theory of interest rates and crowding out, while a logical theory, is not a realistic description of how interest rates are set in modern financial systems, or of the consequences of government deficit spending. Which of the following factors best explains why loanable funds theory is misleading?

Investment spending facilitates saving rather than savings being required before investment spending can take place. The official interest rate is not determined by the demand for loanable funds. Instead, the central bank sets the official interest rate.

Central banks can always create reserves without limit, which they pay for government deficits.

Money that is saved will not necessarily be made available for investment.

Banks can lend without limit, and create deposits by so doing. The government can always borrow from banks. It is only when the government spends the deposits created that banks need to worry about the reserves. The amount of reserves banks hold depends solely on the amount of savings. To attract more savings, banks increase the interest rate.

If the government does not borrow and spend, private firms can borrow more savings to invest. When private firms borrowing excessively, it places upward pressure on the official interest rate.