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.
If you imagine a big black box around both the Treasury and the Fed, what goes on outside the box, how much money is out of circulation, the interest earned, lack of inflationary pressure, is no different if when money is loaned into the box it is recorded in the Treasury as bonds or in the Fed as excess reserves.
The monetary base has a big strange jump up when they start paying interest on excess reserves.
However, if we subtract excess reserves from the monetary base then it does not look like anything peculiar is going on. This could help explain why there has been little price inflation so far.
If we add excess reserves to the national debt it is then growing even faster and is even less sustainable.
I view this as a clever trick to let the government print almost trillion that does not seem inflationary, so far, but also does not make people worry about a larger national debt. It is like they are hiding a trillion debt right out in the open. It is an amazing magic trick really, but it is just a trick. It does not really make anything better.
The near term inflationary pressure is really lower than one would expect from just looking at the monetary base. However, the hyperinflation risk is higher than one would think from just looking at the official debt and deficit numbers. Really, as far as the size of the potential money flood in hyperinflation, it is like the short term US debt is $2 trillion higher than people think.
Source: Howfiatdies.blogspot.com
