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Warsh: Shrink Fed Balance Sheet for Lower Rates
2 Feb
Summary
- Shrinking the Fed's balance sheet could enable lower interest rates.
- The Fed's balance sheet is over $6.5 trillion, down from $9 trillion.
- Easy money policies have driven inflation, according to Warsh.
Kevin Warsh contends that the Federal Reserve's balance sheet has become "bloated," contributing significantly to inflation. He advocates for shrinking this balance sheet, suggesting it could pave the way for lower interest rates.
The Fed's balance sheet, currently exceeding $6.5 trillion, has been a key driver of liquidity in financial markets since the 2008 crisis and the Covid-19 pandemic. While the Fed has already begun a process of quantitative tightening, reducing its holdings from a peak of nearly $9 trillion in 2022, Warsh proposes broader changes.
Warsh suggests that the current "ample reserves" regime, where the Fed pays interest on bank reserves to influence rates, has made money too accessible on Wall Street while credit remains tight for Main Street. He believes redeploying this liquidity could benefit households and businesses.
However, efforts to shrink the Fed's balance sheet have previously led to market volatility, such as a spike in repo rates in 2019. Fed officials have also cited risks to money markets as a reason for halting balance sheet reduction. Implementing these changes may face challenges, including potential opposition from banks regarding the Fed paying interest on reserves.
