Miran outlines paths to shrink Federal Reserve balance sheet
Federal Reserve Governor Stephen I Miran discussed the prospects for shrinking the central bank's balance sheet at the Economic Club of Miami. He outlined reasons for reduction, deemed it a solvable challenge, and proposed potential paths forward.
The case for a smaller footprint
Governor Miran articulated several reasons for reducing the Federal Reserve's balance sheet, aiming for a minimal footprint in markets.
He highlighted the goal of minimizing government-induced distortions, lowering the chances of mark-to-market losses, and protecting the boundaries between monetary and fiscal policy.
A smaller balance sheet also preserves 'dry powder' for future crises.
Miran detailed the evolution of the Fed's balance sheet policy from a 'scarce' reserves regime before 2008 to an 'ample' and 'abundant' reserves regime post-crisis, largely due to quantitative easing.
He posited that shrinking the balance sheet is a 'solvable challenge,' rejecting the notion that it cannot be done.
The challenge involves determining the optimal size, whether a return to scarce reserves is necessary, and if such a return is desirable given potential tradeoffs like increased short-term rate volatility and more active management from the Fed.
Unlocking reduction strategies
Miran outlined various measures to reduce the balance sheet while potentially retaining an ample-reserves policy.
These actions, detailed in a co-authored working paper, include easing liquidity coverage ratio requirements, destigmatizing standing repo operations and discount window usage, and engaging in more active open market operations.
Other steps involve making alternatives to reserves more liquid and adjusting the effective federal funds rate.
Miran suggested a realistic target for reduction could be around 15-18 percent of GDP, translating to a $1 trillion to $2 trillion decrease.
He emphasized the critical importance of a slow pace of reductions, allowing securities to mature rather than selling them outright, to ensure financial markets can absorb them with minimal disruption.
A pragmatic vision for balance sheet normalization
Miran's speech offers a detailed, pragmatic roadmap for quantitative tightening, moving beyond theoretical debates to concrete policy options.
His emphasis on a gradual, well-communicated approach provides crucial guidance for market participants.
The detailed 'User's Guide' paper underscores a serious internal Fed effort to prepare for this complex transition.