Introduction to the Fed’s Balance Sheet Reduction
The US Federal Reserve has been working to reduce the size of its holdings, and according to Governor Christopher Waller, there is still some way to go. In a recent speech, Waller provided insight into the potential target size for the Fed’s balance sheet, which currently stands at $6.7 trillion.
The Current State of the Fed’s Balance Sheet
The Fed’s balance sheet has been reduced over the last three years, after more than doubling in size to a peak of $9 trillion due to COVID-19 era bond purchases. The current balance sheet consists of $3.3 trillion in bank reserves, with the goal of reducing reserve balances through the natural maturing and prepaying of securities.
A Hypothetical Target for the Fed’s Balance Sheet
Waller presented a hypothetical scenario, where the Fed’s balance sheet could potentially stand at $5.8 trillion, with $2.7 trillion in reserves. This estimate is informed by the need to maintain ample reserves, as well as the desire to move holdings to shorter-dated securities. The Treasury Department’s account with the central bank would also be reduced to $780 billion.
Informing the Estimate
The estimate of $5.8 trillion is based on the idea that reserves should not fall below 8% of GDP, as suggested by money market turbulence in the fall of 2019. This metric provides a rough guide for determining the appropriate size of the Fed’s balance sheet.
Normalization of Monetary Policy
The reduction of the Fed’s balance sheet is part of a broader effort to normalize monetary policy. After years of unprecedented intervention, the Fed is seeking to return to a more traditional approach, with a smaller balance sheet and a greater emphasis on shorter-dated securities.
Conclusion
In conclusion, the Federal Reserve still has some way to go in reducing the size of its holdings, with a potential target of $5.8 trillion. The normalization of monetary policy is an ongoing process, and the Fed will likely continue to let maturing and prepaying securities roll off its balance sheet, reducing reserve balances and moving towards a more traditional approach to monetary policy.
