Federal Reserve Chairman Kevin Warsh said on Wednesday that while he has not changed his mind that a large central bank balance sheet should be shrunk, any notable change in policy on this matter will take time and be well communicated.
“Decisions will be well deliberated publicly, well understood, and will not be implemented until financial markets have come to understand what those are,” Warsh said at a European Central Bank event in Sintra, Portugal.
“It took us about 18 years to find our way into this big balance sheet, which again, in my biased view, borders on fiscal policy" and it will take some time to figure out where things go next. "I'm open-minded on the question -- we're not going to prejudge it, but I want interest rate policy" to be the main tool used by the central bank, the official said.
"My four weeks at the Fed haven't disabused me of that idea" that Fed holdings should be smaller, Warsh said.
Warsh returned to the Fed in May after an extended period of criticizing the central bank for the expansive size of its balance sheet, which is now at $6.7 trillion. That's down from the $9 trillion peak hit in 2022 but it remains much larger than the $4.2 trillion seen just ahead of the onset of the COVID-19 pandemic in 2020 and the sub trillion dollar size seen before the onset of the financial crisis two decades ago.
The Fed has in several episodes bought massive amounts of Treasury and mortgage debt in a bid to stabilize financial markets in times of stress and to augment the stimulative power of conventional interest rate policy. That's left Fed holdings much larger than they once were, and generated a complex suite of Fed tools to manage market liquidity in a time where financial institutions hold massive amounts of reserves on hand.
Economists and some Fed officials believe the Fed will be able to shrink its holdings further by allowing banks to hold less emergency liquidity, although that could increase the risk of financial stability troubles. That said, how the Fed current manages interest rates money market conditions ultimately limit how far the central bank can shrinking holdings without destabilizing markets.
Most experts believe any shift toward smaller Fed holdings will take some time to happen given the complexity of the issue.
