- sheet expansion were initially sopped up by the treasury ’ s supplemental financing program, total excess reserves have climbed to more than $ 700 billion from nearly zero at the beginning of the crisis. the sharp rise in excess reserves has caused the monetary base, which is simply the sum of currency plus total reserves, to expand significantly. the increases in excess reserves and in the monetary base generated by the fed ’ s balance - sheet growth have led some observers to worry that this expansion will ultimately prove inflationary. proponents of this view say that the monetary base, the broad monetary aggregates, total credit outstanding and inflation have historically tended to move together, at least over longer time periods. thus, if the monetary base is growing rapidly, as it has been over the past year, the view is that this growth will ultimately lead to inflation. is this concern well founded? the answer is that in a world where banks could not be paid interest on excess reserves, these persistent high reserve balances would indeed have the potential to prove inflationary. 2 in that world, the excess reserves are likely to lead ultimately to an overly accommodative monetary policy. the story goes like this : if banks are earning no interest on their excess reserve holdings, they will be willing to lend those reserves out to any creditworthy borrowers as long as the interest rate is positive after adjusting for risk. the borrowers would then spend these monies, thereby boosting economic activity. the funds would not disappear, but instead would flow back into the banking system as they were deposited by those who had received the income generated by the increase in spending, thus replenishing the reserves that had been lent out in the first round of lending. this would result in a new stock of excess reserves that would then lead to a second round of credit creation and a further increase in economic activity. this cycling of excess reserves into credit creation, and the corresponding increase in economic activity, would continue until the excess reserves were fully absorbed by an increase in currency outstanding and / or an increase in required reserves associated with the rise in the amount of banking deposits. inflation would rise as the excessive credit creation generated by the excess reserves led to an overheated economy and a rise in inflation expectations. but that is not the world in which we now live. because the federal reserve now has the ability to pay interest on excess reserves ( ioer ), it also now has the ability to prevent excess reserves from leading to excessive credit creation. because the

able to enter the labour market immediately, and who are not participating in a labour market policy programme. bis central bankers ’ speeches however, it is not certain how actual unemployment is to be defined if the intention is to measure the spare capacity of the labour market. youth unemployment can be taken as an example. in october 2007, statistics sweden went over to reporting unemployment according to an internationally - established standard. full - time students who have looked for work and could have worked were now reported as unemployed. this change meant that unemployment in the age group 15 – 24 increased strongly, even though this group ’ s main activity was studying. the number of people unemployed in relation to the number of people in the labour force in the category young people was about 25 per cent in 2010. using the previous reporting method, unemployment would have been 15 per cent. 5 for total unemployment, the changed method meant that measured unemployment increased by about 2 percentage points. neither is it clear how individuals participating in labour market policy programmes should be classified. for example, individuals obtaining what are known as entry - level jobs, new start jobs or sheltered employment through the swedish public employment service are counted as employed under statistics sweden ’ s classification, while those participating in vocational training courses ( for example ) are counted as unemployed. these classifications are not selfevident. while attending these programmes, the participants are probably less active in their job - seeking. if an unemployed person stops looking for work while participating in a programme, perhaps we could question whether this person should still be considered to be unemployed. so actual unemployment can be measured in different ways : including or excluding full - time students who are looking for work and can work ; including or excluding individuals participating in labour market policy programmes. it is unclear which of these definitions is the most relevant measure of welfare and which measure should be used in the monetary policy analysis. covariation with economic activity … regardless of how we choose to define and measure actual unemployment, experience shows that it clearly covaries with economic activity, albeit with a certain time lag. at the start of an upturn in economic activity, the number of hours worked and employment normally increase after a time lag, compared with gdp. this is reflected by the increase of output. it is due to companies initially using existing personnel to a greater extent. in downturns, the reverse is common : companies retain their personnel as long as it remains uncertain whether the downturn will be long - lasting, meaning that output temporarily