Federal Reserve Governor Michael Barr stated that shrinking the central bank's balance sheet should not be a primary policy objective, and many proposed plans to achieve this goal could, in fact, endanger financial stability.
Barr made these remarks at an event in midtown Manhattan, following the appointment of a new Fed Chair who has advocated for reducing the Fed's balance sheet and scaling back its substantial market presence. Barr argued that some proposals related to balance sheet reduction would actually expand the Fed's influence in the markets.
In his prepared speech, he noted: "Many proposals to achieve this objective would weaken banks' resilience to risks, impede the normal functioning of money markets, and ultimately threaten financial stability."
Barr explained that under the ample reserves framework—a monetary operating mechanism established after the 2008-2009 financial crisis—money market volatility should remain low in normal market conditions. He pointed out that even if the Fed returned to a scarce reserves framework, considering the necessary regulatory intensity and market intervention, it would not genuinely reduce the Fed's market footprint.
Barr believes that if the financial system lacks sufficient reserves, the payment system could be disrupted: banks might slow the pace of external payments to conserve liquidity, leading to congestion in the funding market and various liquidity pressures.
Additionally, Barr mentioned that if depositors collectively withdraw funds while banks have insufficient reserve buffers, it could easily trigger market panic. He added that the 2023 banking turmoil demonstrated that liquidity requirements for banks should be tightened, not relaxed.
He stated: "Reducing the Fed's balance sheet is itself a misguided goal, and weakening the resilience of the banking system is an even more misguided approach."
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