Federal Reserve could cut balance sheet by $2tn without market turmoil, says Miran

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A top Federal Reserve official has claimed the US central bank could eventually shrink its bloated $7tn balance sheet by up to $2tn, without roiling financial markets.

Stephen Miran, a Fed governor, on Thursday said measures such as easing liquidity regulations and destigmatising the use of some of the central bank’s lending operations could pave the way for “$1tn to $2tn of balance sheet reduction”.

Miran added his ideas would need to be “studied and calibrated”, with the implementation process taking “several years”.

Kevin Warsh, President Donald Trump’s pick to replace Fed chair Jay Powell, has also called for the central bank to shrink what he believes has become an excessively large balance sheet.

People familiar with Warsh’s thinking said he supports a measured approach for reducing the size of the balance sheet without causing ructions in financial markets.

Treasury secretary Scott Bessent has also called for a review of US liquidity regulations.

The Fed’s balance sheet has expanded rapidly since the 2008 financial crisis from multiple multitrillion-dollar bond-buying sprees known as quantitative easing. It peaked at a record high of about $9tn during the Covid-19 pandemic as the central bank became the largest holder of US government debt.

Efforts to shrink it closer towards its pre-pandemic level ended last year, following a three-year quantitative tightening programme in which maturing bonds were allowed to roll off without being replaced.

The balance sheet is now about $6.7tn, with Fed officials pledging to expand it further should private lenders demand more reserves. The halt to QT followed jitters in short-term borrowing markets that sent funding costs for some banks well above the Fed’s target range.

Miran said the US central bank would need to give “market guidance on how the new mechanisms will function”.

“Once the process begins, I would counsel a slow pace of reductions to ensure the private sector can absorb all the securities shed off our own balance sheet,” he said in Miami on Thursday. “I am excited that all this can happen, but, if or when it does, I expect it to proceed slowly.”

Miran’s calls for the Fed to consider relaxing liquidity regulations echo similar remarks by other central bank officials.

However, his estimates of the extent to which banks’ demand for reserves can be reduced are based on research he co-authored with other Fed economists and are much larger than those of other central bank officials.

Fed governor Christopher Waller earlier this year said loosening liquidity requirements was likely to lower demand, but only by about $600bn.