As policy-wonk buzzwords go, few are more important these days than “ample." What that word means, or rather what the Federal Reserve thinks it means, has become a $7.4 trillion question hanging over the U.S. economy. The issue is the Fed’s balance sheet, which currently stands at about that level.
The Federal Open Market Committee decided last week to slow the pace at which the balance sheet will shrink. Since June 2022, the central bank has been allowing up to $60 billion a month in Treasurys to roll off and up to $35 billion in mortgage-backed securities. That rate will now slow to $25 billion per month for Treasurys.
This sounds counterintuitive. The Fed is fighting stubborn inflation. Quantitative easing (the purchases of bonds through which the central bank expanded its balance sheet after 2008) marked a prominent effort to stimulate the economy and inflation.
Quantitative tightening to unwind those purchases seemed to be part of the Fed’s plan to combat inflation starting in 2022. Why slow down now? Because taming inflation isn’t the central bank’s only task (and the Fed isn’t sure QE matters to inflation anyway). The central bank also has changed the way the American financial system operates in significant ways since 2008 and this is limiting the Fed’s ability to shrink its balance sheet.
The problem is the central bank’s liabilities, which necessarily have increased in tandem with its assets. One liability in particular ballooned under QE: bank reserves. These are the deposits commercial banks hold at the Fed to guarantee their liquidity, and they’re huge: $3.3 trillion as of the most recent count, and that already is down from $4.3 trillion at the peak, in late 2021.
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