Shrink the Fed’s balance sheet?

There’s a strong possibility the Federal Reserve, under new leadership, will focus on reducing the reserves on its balance sheet.

In a speech he gave on Thursday at the Economic Club of Miami, Federal Reserve Board Governor Stephen Miran said the Fed should revert back to its pre-2008 financial crisis policy of holding “scarce reserves,” and laid out a roadmap for doing so.

The central bank “should aim for as small a footprint in markets as possible to minimize government-induced distortions,” Miran said. He added that a smaller balance sheet keeps “the Fed out of the credit allocation game across sectors” and preserves “dry powder for a scenario in which policymakers must again confront the zero lower bound on interest rates.”

Miran, also a member of the rate-setting Federal Open Market Committee, laid out a guide that he said would allow a “$1 trillion to $2 trillion of balance sheet reduction.” He also said that skeptics “simply lack imagination.”

Kevin Warsh, whom President Donald Trump nominated to replace Jerome Powell as the next Fed chair, has also signaled support for reducing the Fed’s balance sheet.

“In my judgment, we should be shrinking the central bank balance sheet, taking the Fed out of these markets unless and until there’s a crisis,” Warsh said in a conversation that the Hoover Institution posted last summer. “And in so doing, you’d have less inflation that way.”

Not all economics experts are on board with the idea.

Substantially reducing the Fed’s balance sheet is “a very risky idea,” Stephen Cecchetti, a professor of international finance at Brandeis International Business School, and Kim Schoenholtz, a clinical professor emeritus at the NYU Stern School of Business, recently wrote in a Financial Times column.

Such a move “could stir interest rate volatility, limit credit supply, cause turbulence in financial market and even pose a risk to financial stability,” the two wrote.

As of March 23, the Fed had $6.7 trillion of assets on its balance sheet, down from a peak of $8.9 trillion in April 2022. The bulk of the assets are Treasury and mortgage-backed securities.