Excess Reserves Is like Government Debt

financialsense.com / By Vincent Cate / February 5, 2013

The central bank is created by the government, it operates under rules and laws created and changed by the government, the leaders are appointed by the government, it is given governmental regulatory powers over banks, and at least in the US case the profits go to the government. For the rest of this article, try to think of the Federal Reserve as just part of the government. So if a bank gives their money to the Fed and earns interest or gives it to the Treasury and earns interest, just think of it as giving it to the government and earning interest.

The bank excess reserves at the Fed used to be tiny amounts, not earning interest, just part of the money supply. In Oct 2008 the Federal Reserve started paying interest on excess reserves and the size has shot up since then. People understand that this money “just sitting in the banks and not lent out” is not inflationary. It has let the Fed print lots of money without causing lots of inflation, so far.

I think the best way to think of excess reserves is as part of the national debt. Since it is owed by a government agency to something outside government, and earns interest, it really is like a government debt. Paying interest on excess reserves keeps some money off the street, just like short term government debt, and so reduces inflationary pressure.

When excess reserves did not pay any interest it was correct to count them as part of the money supply, which does not pay interest. When they are paying interest they are like government debt and should be counted as such.

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