The US Fed’s balance sheet: It cannot be shrunk any further

It wouldn't make space for lower interest rates in the US economy

- BILL DUDLEY

Fed chief Jerome Powell has endorsed the current 'ample reserves' regime.

(REUTERS)

The US Federal Reserve’s balance sheet has shrunk from a peak of $8.97 trillion in April 2022 to $6.56 trillion as it has unwound much of its Treasury and agency mortgage-backed security purchases undertaken as pandemic relief for the economy. This has bought the demand and supply of reserves into a closer balance.

Some advocate shrinking the balance sheet further for reasons ranging from reducing the Fed’s financial-market footprint to allowing more volatility in money market rates (in order to better monitor incipient market stresses) and enabling more rate cuts. These advocates miss two points. First, that would not be an easy task, as it would require a dramatic change in how the Fed conducts monetary policy. Second, because a smaller balance sheet would not exert much restraint, it would not help lower short-term rates much.