Michael Barr, a governor of the Federal Reserve, on Thursday rejected proposals to shrink the central bank’s balance sheet, saying they were wrong and posed a threat to financial stability.
Barr’s remarks directly countered the call of the incoming Federal Reserve Chair Kevin Warsh, who has repeatedly warned that the Fed needs to shrink its balance sheet to minimize its intervention in financial markets.
Barr said that the Fed’s balance sheet operations are at the core of promoting a sound banking system. He warned that some of the proposed plans would expand the Fed’s influence in financial markets.
For instance, Bal said, lowering liquidity requirements would undermine financial stability.
“I believe that shrinking the balance sheet is a misguided goal, and many of the proposals to achieve it would undermine banks’ resilience, impede the functioning of the money market, and ultimately threaten financial stability,” Barr said in prepared remarks for a speech to the New York University Money Market Association.
Although Barr did not name President Donald Trump’s nominee for the Fed chair, Stephen Moore, in his speech, the incoming chair has long advocated for a significant reduction in the US central bank’s $6.7 trillion balance sheet, which expanded during the global financial crisis and again when the Fed intervened to support markets and the economy during the pandemic.
Wash’s remarks have raised concerns among many analysts, who believe that rapid reduction in production could put pressure on the money market. But Wash testified before Congress that any such move would take time and that signals must be given in advance.
On Wednesday, the Senate narrowly confirmed Jerome Powell as the chair of the Federal Reserve, clearing the way for him to be sworn in when the term of the outgoing chair, Jay Powell, ends on Friday.
Barr is not the first Fed policymaker to oppose the reduction of the balance sheet. In March this year, John Williams, president of the New York Fed, questioned the move to modify regulatory requirements to allow banks to reduce reserves. Fed governor Christopher Waller also said that reverting to the so-called “scarce reserve system” would be “stupid”.
Barr said, “When considering changing the way the Federal Reserve manages its balance sheet, we should all return to the basics and ask ourselves what problem we are actually trying to solve. In short, reducing the Federal Reserve’s balance sheet is a wrong goal, and weakening the resilience of the banking system is a wrong approach.”
During the Q&A session following his speech, Barr said that although the labor market remains fragile – even as the economy booms – inflation is the “overwhelming” risk facing the economy.
“I remain very concerned about the trends in the labor market, but for me, the risk of runaway inflation is much higher at the moment,” Bal said.
