FAQs on a Smaller Fed Footprint

This report analyzes the mechanisms and constraints for shrinking the Federal Reserve's balance sheet through passive or active Quantitative Tightening (QT). It highlights that while reduction is possible, it is limited by bank reserve demand, regulatory requirements, and the slow natural runoff of mortgage-backed securities.

Key Takeaways

• 1.The Fed can reduce its balance sheet through passive runoff (letting securities mature) or active sales, with passive QT being more predictable but slower.
• 2.Balance sheet reduction drains bank reserves and liquidity, potentially moving the system from 'ample' to 'scarce' reserves, which increases volatility.
• 3.Reducing Agency MBS holdings naturally will take years due to high mortgage rates slowing prepayment speeds; active sales would be disruptive and costly.

Table of Contents

• Key expectations
• How can the Fed reduce the size of the balance sheet?
• What are some of the implications of active sales versus passive runoff?
• With mortgage rates elevated, won't passive runoff of MBS holdings take time?
• Would letting agency MBS roll off the balance sheet conflict with efforts to reduce mortgage rates through GSE repurchases?
• Wouldn't active QT incur additional losses for the Fed?
• Can the Fed transfer assets to the Treasury, or could they sell agency MBS holdings to the GSEs?
• Are there ways that the balance sheet can shrink without leading to excessive volatility in short-term funding markets?
• Step 1: Reduce reserves modestly from "ample" to "scarce"
• Step 2: Conduct temporary OMOs to manage fluctuations in reserve demand
• Step 3: Reduce the average TGA balance
• Box 1: What is the Treasury-Fed Accord of 1951
• Are regulatory changes needed to reduce the balance sheet?
• How could the Fed go about shortening the average maturity of the SOMA portfolio?
• How might the US Treasury respond to a shorter SOMA WAM?
• What does a Fed with a "smaller footprint" mean for the rates market?

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