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2026-02-17 22:46:53
【Wash may hope the Fed will shrink its balance sheet, but this may be difficult to achieve】 (1) Although Warsh, who has been nominated to be the Fed chairman, hopes to shrink the Fed's balance sheet, this goal may be difficult to achieve without major reforms to the financial system. The Fed's current monetary policy mechanism relies on the banking system holding a large amount of funds. The liquidity of the financial system and the use of regulatory tools determine the limit of its asset size reduction, and it is necessary to maintain the stability of the money market. (2) Experts warn that a large-scale balance sheet reduction may trigger market turmoil. Analysts at the Bank of Montreal said that unless regulatory reforms reduce banks' demand for reserves, a significant balance sheet reduction is unrealistic, and the reforms will take several quarters to take effect. Other scholars pointed out that a large-scale balance sheet reduction under the current framework will expose the short-term market to huge volatility risks, which is not worth the effort. (3) Warsh was nominated by the Trump administration at the end of last month and has long criticized the Fed's balance sheet for being too large. Since the financial crisis and the COVID-19 pandemic, the Fed has purchased bonds on a large scale, with the asset size reaching a peak of $9 trillion. After two rounds of balance sheet reduction, it has dropped to the current $6.7 trillion, but it is still far higher than the level before the bond purchases. Warsh believes that the huge asset size distorts the financial market and advocates further balance sheet reduction to release liquidity. (4) However, his demands face multiple challenges: the banking system needs to maintain high reserves, and withdrawing liquidity could lead to the federal funds rate spiraling out of control. Morgan Stanley points out that while rule adjustments can reduce liquidity demand, they will exacerbate financial stability risks; JPMorgan Chase also believes that even with strengthened liquidity support mechanisms, the possibility of the Federal Reserve restarting balance sheet reduction remains small. Most observers believe that financial realities will inhibit Warsh's ability to drive significant changes.
