** Reducing the Fed's balance sheet **
Ten days ago, I was part of a discussion at @BrookingsInst on how to shrink the Fed's balance sheet with Darrell Duffie and @WenxinDu. I tried to lay out the discussion in terms that, hopefully, clarify it to a broader set of economists. Here are the main points: 🧵
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1) Bank's demand for reserves at the central bank have increased because each of the four economic determinants' of that demand have shifted since the great financial crisis.
(Darrel Duffie's paper makes this point)
brookings.edu/wp-content/upl…
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2) A simple answer to this shift in demand is to increase the inelastic supply of reserves. This is what we have done for the past 17 years.
(I wrote about the implications it has for monetary policy ten years ago at Jackson Hole.)
personal.lse.ac.uk/reisr/pap…
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3) But, today, the Fed wants to reduce the size of the balance sheet. There are pros and cons for this, but let us take the desire to shrink as given.
(The incoming chair Kevin Warsh gave some reasons for this goal).
hoover.org/sites/default/fil…
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4) Less debatable, the Fed should aim to (i) stay close to the optimal supply of reserves (Friedman rule), and (ii) prevent a financial crisis in money markets as a result of spikes in demand for liquidity.
(See governor Stephen Miran's approach)
federalreserve.gov/econres/f…
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5) Policies to reduce the balance sheet of the Fed are synonymous with policies that reduce the demand for bank reserves. You cannot do one without the other
(Lori Logan and Sam Schulhofer-Wohl @DallasFed have been making this point for a while.)
federalreserve.gov/monetaryp…
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6) Keeping interest rates in money markets from becoming dangerously volatile while reducing the size of the balance sheet requires committing to an elastic supply of reserves.
(Isabel Schnabel has several speeches on this)
ecb.europa.eu/press/key/date…
Apr 6, 2026 · 2:06 PM UTC
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7) The elastic supply of money can be achieved by a standing repurchase facility open to banks, along the lines of the ones existing at the Bank of England or the ECB.
(Andrew Bailey laid out the reasons for this strategy at his @FMG_LSE Goodhart 2024 lecture)
bankofengland.co.uk/speech/2…
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8) "Stigma" is an expression used to explain why US banks leave money on the table and do not use some Fed standing facilities. To my ears, this is doublespeak for US supervisory failures and/or flaws in the design of those facilities. They can and should be corrected.
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9) My written comments are here. These will appear in the Brookings Papers on Economic Activity @BrookingsInst.
personal.lse.ac.uk/reisr/pap…
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10) For the full discussion, the video is available here:
youtube.com/live/HrTIj5h1N5I…
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11/end) And for more academic in-depth discussions of this topic see:
What happened since Wednesday in the US repo money markets? Why did banks have to borrow $15.1bn from the Fed's recent lending facility? Could we see this coming? What does it imply for QT?
(good clues in this thread...) [1/5]
ft.com/content/60663a88-6a86… via @ft
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