Barr: Fed footprint beyond balance sheet, warns on cuts
Federal Reserve Governor Michael S. Barr argued that the size of the Fed's balance sheet is the wrong measure of its financial system footprint. He warned that proposals to shrink it would undermine bank resilience and financial stability.
Footprint beyond balance sheet
Barr argues that the Federal Reserve's "footprint" in the financial system extends far beyond the size and composition of its balance sheet.
He states that the Fed's roles in promoting bank safety and soundness, operating the payment system, and supporting overall financial stability are equally crucial.
Barr criticizes proposals aimed at shrinking the balance sheet, asserting that such measures would paradoxically increase the Fed's market involvement by necessitating more frequent lending and interventions.
He warns that these proposals risk undermining bank resilience, impeding money market functioning, and ultimately threatening financial stability.
Barr emphasizes that an integrated approach to central banking, considering all responsibilities and their spillovers, is essential for achieving the Fed's multiple objectives.
The indispensable role of reserves
Barr highlights the critical role of reserves, currently $3 trillion of the Fed's $6.5 trillion in liabilities.
He explains that reserves are the safest and most liquid asset, essential for banking system safety, payment system resilience, and overall economic stability.
Insufficient reserves can lead to payment system bottlenecks and funding market stresses, potentially causing panic during withdrawals.
Providing reserves is costless to the Fed, as interest paid is offset by interest received on its asset portfolio, with excess earnings returned to taxpayers.
The current ample-reserves regime, controlling the federal funds rate via administered rates like IORB, ensures limited money market volatility.
A necessary defense
Barr's speech firmly defends the Federal Reserve's current operational framework, pushing back against calls for a smaller balance sheet.
He articulates the interconnectedness of the Fed's functions, arguing that a narrow focus on balance sheet size overlooks broader stability implications.
His remarks provide a window into the Fed's internal concerns regarding potential policy missteps, advocating for a holistic approach.