Dallas Fed President Lorie Logan believes that the Federal Reserve should adopt a more cautious approach when it comes to reducing its balance sheet. In a recent talk at the American Economics Association meeting in San Antonio, Texas, Logan emphasized the importance of gradually ending the program to avoid any abrupt stops.
According to Logan, slowing down the normalization process can lead to a more efficient balance sheet in the long run. It would allow for a smoother redistribution of assets and decrease the likelihood of premature termination. However, she did not provide any indication as to when the Fed might actually put an end to its balance-sheet reduction.
To determine when to slow down the shrinkage of the balance sheet, Logan suggested paying close attention to overnight reverse repo balances. Once these balances reach a low level, she believes it would be appropriate to take action.
Logan also expressed support for initiating a discussion in the coming weeks to establish the guidelines for slowing down the runoff of the balance sheet. This decision was initially revealed in the minutes of the Fed’s December meeting.
Since the summer of 2022, the Fed has been aggressively reducing its balance sheet by allowing approximately $100 billion of maturing securities to roll off each month. As a result, the total balance sheet has contracted by around $1.3 trillion, bringing it down to $7.7 trillion.
In summary, Logan argues that a gradual approach to ending the balance-sheet reduction program would lead to a more effective outcome in the long term. By considering key indicators and carefully assessing the impact of each step, the Federal Reserve can ensure a smoother transition to a more balanced financial landscape.
Quantitative Tightening and the Federal Reserve’s Balance Sheet
The Federal Reserve (Fed), under the leadership of Chairman Jerome Powell, has been undergoing a process called quantitative tightening (QT) to reduce the size of its balance sheet. However, recent developments suggest that this program may come to an end sooner than expected.
According to Logan, an expert in the field, there is currently an abundance of bank reserves and overall liquidity in the financial system. The Fed has emphasized the importance of banks holding “ample reserves” without specifying a specific target for the balance sheet size.
Interestingly, Chairman Powell has stated that the Fed will continue shrinking its balance sheet even if interest rates are reduced by central banks. This signals a commitment to the ongoing initiative.
The first attempt at QT was made by the Fed in 2017. However, it encountered unforeseen difficulties that prompted an early termination of the program in September 2019. At that time, the balance sheet stood at approximately $3.8 trillion.
In response to the economic impact of the COVID-19 pandemic, the Fed saw its balance sheet expand significantly. The central bank purchased undesirable securities in exchange for cash and launched emergency lending programs. As a result, the balance sheet reached a peak of approximately $9 trillion.
Paul Ashworth, Capital Economics’ chief North America economist, predicts that the Fed will begin reducing the size of its balance-sheet rundown by June, effectively ending quantitative tightening by December. Nevertheless, he notes that if economic growth falters more than anticipated, the Fed might accelerate the QT process.
Meanwhile, economists at Bank of America Securities anticipate a complete conclusion to the QT program in June.
In conclusion, while the Fed has maintained ample bank reserves and overall liquidity in the financial system, its quantitative tightening efforts have faced challenges. However, with plans in place to reduce the size of its balance sheet, it remains to be seen how this process will unfold in the coming months.
