Can depository institutions create money using their excess reserves to loan money?

Answer 1

Yes. They can sell their reserves, which are really just deposits by banks at the Federal Reserve, to other banks or simply withdraw them from the Fed, replacing them with cash, and make loans with that cash or buy lending assets such as bonds. See "fractional reserve lending".

Considering the record rise in reserves, we should expect a veritable tsunami of lending any minute. Commercial banks are holding a record proportion of cash predominantly in the form of those reserve deposits at the Fed. They're holding so much that they actually stand to lose money if they don't lend because of the cost of their liabilities versus the next to 0% rates of revenue from those excess reserves. See "borrow short, lend long" and "net interest margin".

Another view holds that the currently high level of reserves on deposit with the Fed ($1.08T as of 10/28/09) will not be reduced without an explicit change in Fed or Treasury policy. The Fed only has a capital level of $52.5B as of 10/28/09. Therefore a material reduction in the amount of reserves would require a concurrent reduction in assets or an offsetting increase in liabilities to maintain the solvency of the Fed's balance sheet. A significant reduction in assets would require the sale of Treasuries and Agency securities held by the Fed and therefore a reversal of current Fed policy to purchase such securities to lower interest rates for mortgages. Prior examples of increased liabilities include the Treasury's Supplemental Financing Program(SPF) begun in September 2008 where Treasuries were sold and the proceeds deposited with the Fed in a special account. Recent constraints imposed by the current debt ceiling of $12.1T have led to reductions in the SPF account and offsetting increases in the level of reserves on deposit. From this point of view, the arrival of any tsunami of new lending will necessarily be preceded by explicit policy changes that should not be expected before an increase in the debt ceiling at least $500B over annual deficit requirements of about $1.4T or a Fed announcement that Treasury and Agency sales are to begin.

High-powered money has doubled in the US in a 3 month period or so. All of that new cash is powerful enough to double the amount of credit in the US, currently $55t.

This is all safe, for the moment, because we are rapidly deflating. Once we start inflating again, Mr. Bernanke will sell the assets on the Fed's balance sheet, and things will return to normal, removing the record amount of cash in the US.