A significant push to substantially reduce the Federal Reserve's balance sheet is emerging within the central bank, aligning closely with the White House's stance.
On Thursday, March 26, Federal Reserve Governor Miran indicated that, through measures such as easing liquidity regulatory requirements and reducing the use of central bank lending facilities, the Fed's balance sheet could ultimately be reduced by $1 to $2 trillion from its current level of approximately $7 trillion.
He pointed out:
Once the process begins, I recommend a slow and measured pace of reduction to ensure the private sector can fully absorb the securities released by the Fed.
He stated:
I am excited about all of this happening, but if it does occur, I hope it proceeds slowly.
Governor Miran added that the Fed needs to provide clear guidance to the market on "how the new mechanism will operate." He also emphasized that the related proposals still require "in-depth research and careful calibration," with the implementation process expected to take "several years."
Previously, Fed Governor Waller suggested that relaxing liquidity requirements could lower banks' demand for reserves, but only by about $600 billion.
Reportedly, Governor Miran's estimate is based on research he co-authored with other Fed economists and is significantly larger than estimates from other central bank officials.
It is noteworthy that Kevin Warsh, a candidate nominated by former President Trump for the next Fed Chair, also advocates for reducing the size of the balance sheet. He supports advancing this process prudently to avoid causing shocks to financial markets.
U.S. Treasury Secretary Janet Yellen has previously called for a review of U.S. liquidity regulations. The high degree of alignment among these three positions has significantly intensified external discussion regarding the future direction of the Fed's balance sheet policy.
**Historical Expansion of the Balance Sheet**
The Fed's balance sheet has undergone several rounds of massive expansion since the 2008 financial crisis. At that time, the Fed initiated multiple rounds of quantitative easing, injecting liquidity into the market through large-scale bond purchases.
Following the COVID-19 pandemic, the balance sheet swelled to a historical peak of nearly $9 trillion, briefly making the Fed the largest holder of U.S. Treasury debt.
Subsequently, the Fed commenced a three-year quantitative tightening program, allowing bonds to mature without reinvesting the proceeds, in an attempt to shrink the balance sheet back towards pre-pandemic levels.
However, this process was halted last year. Instability in short-term funding markets emerged, with financing costs for some banks rising significantly above the Fed's target range, forcing the central bank to hit the brakes. The Fed's balance sheet currently stands at approximately $6.7 trillion.
Fed officials have stated that if demand for reserves from private borrowers increases, further expansion of the balance sheet remains a possibility.
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