As Frank Shostak predicted in his podcast last week or so on mises.org, the banks are now holding excess reserves. The bailout package authorizes the Fed to start paying interest on bank reserves, and they have announced a plan to do so.
If you look at the numbers, the banks lately have had around $40 billion in reserves, which is close to the required reserve amount, and checkable deposits are multiplied off of that to the tune of about $300 billion in checking, and another $300 billion in "other checkable deposits."
But now the banks are holding around $109 billion in reserves, which means $69 billion is in excess of what is required. Banks usually like to loan out as much as possible to earn interest, rather than have reserves sit there. So this is unusual, and makes me think of the Great Depression when the same thing was happening. The Fed was essentially pushing on a string, pumping in reserves to get banks to start lending again.
So far, this doesn't seem to harmful in terms of inflation as long as this money is sitting there doing nothing. But what happens after the credit crunch when banks start lending out these excess reserves and the money multiplier takes effect?
My question is, to any students of the Great Depression out there, what happened back then: did the Fed remove excess money supply when the economy finally started to recover, or did it stay there and cause rapid inflation? Could we see a repeat of this today?
We already have a discussion underway at http://mises.org/Community/forums/t/3992.aspx
As for your question, so long as the Fed targets interest rates it has to radically change the monetary base to match the radical changes in the banks' demand for reserves. If the banks tommorow decide it's okay to lend again, the Fed will have to withdraw reserves and sell treasuries to keep interest rates at target.
The fallacies of intellectual communism, a compilation - On the nature of power