Barr, Efficient and Effective Central Banking: Beyond the Balance Sheet

Home News & Events Speeches Speech PDF <div class="js-disabled text-center"> <span class='icon icon-alert icon--jsAlert'></span> <span><strong>Please enable JavaScript if it is disabled in your browser or access the information through the links provided below.</strong> </span> </div> May 14, 2026 Efficient and Effective Central Banking: Beyond the Balance Sheet Governor Michael S. Barr At the Money Marketeers of New York University, New York, New York Share Thank you for the opportunity to speak to you today.1 There has been a lot of discussion of late about reducing the size of the balance sheet of the Federal Reserve to reduce our "footprint" in the financial system. I think it is important to frame the discussion, first by being clear about the nature of the problem to be solved and then weighing the tradeoffs of any remedies. I think shrinking the balance sheet is the wrong objective, and many of the proposals to meet this objective would undermine bank resilience, impede money market functioning, and, ultimately, threaten financial stability. Some would actually increase the Fed's footprint in financial markets. That's because the Fed's footprint in the financial system consists not only of the duration, composition, and size of our balance sheet (which are distinct issues), but also our roles in promoting the safety and soundness of banks, running the backbone of the payment system, and supporting financial stability. It doesn't make sense to talk about "the Fed's footprint" without taking into account these key functions and the way they interact. Some of the prominent proposals to reduce the Fed's balance sheet would have perverse effects that would actually increase the Fed's footprint in the financial system. For example, some proposals would increase the frequency of Fed lending and transactions in markets, both to implement monetary policy on an ongoing basis and, in extremis, to engage in interventions to preserve financial stability. Today I am going talk about what I see as efficient and effective central banking—central banking that holistically implements monetary policy, provides meaningful oversight of financial institutions, supports payment system functioning, and, in the Fed's case, also includes serving as the fiscal agent to the Treasury Department. We can't ignore any of these responsibilities, so when considering changes to our policies and practices, we need to consider the spillovers to our other duties and evaluate the tradeoffs. This integrated approach to central banking is essential to achieving the Fed's multiple objectives. I will make two broad points today. First, the size of the Fed's balance sheet is the wrong measure of the Fed's footprint in financial markets, and, second, many of the proposals being floated to address this purported problem would make our monetary policy operations less efficient and effective and raise financial stability risks. The Fed's Balance Sheet Let's start with an understanding of the Fed's balance sheet. The Fed's liabilities largely consist of reserve balances (the deposits that commercial banks hold with the Fed), currency in circulation, and the balance of the Treasury General Account (TGA), which is the Treasury's account with the Federal Reserve.2 The Fed's assets are mostly Treasury securities, and we also have a sizable portfolio of agency mortgage-backed securities (MBS), most recently acquired in response to the COVID-19 crisis to address the extraordinary conditions at that time.3 The Federal Open Market Committee (FOMC) conducts monetary policy with an ample-reserves regime. This means that control of our policy rate, the federal funds rate, is accomplished primarily by setting our administered rates, particularly the interest on reserve balances (IORB) rate. You can think of this regime graphically, as the Fed supplying reserves on the flat portion of the reserve demand curve, so that normal changes in the supply and demand for reserves lead to only limited variations in price.4 In an ample-reserves regime, when we are getting it right, there should be limited money market volatility under normal conditions. The Role of Reserves in the Banking System Currently, reserves, which as I said are deposits of depository institutions at the Fed, represent $3 trillion of the Fed's $6.5 trillion in liabilities. Some recent proposals have focused on shrinking reserve demand as a means of facilitating a shrinking of our balance sheet. Let me take a step back and explain why supplying reserves is so important. As Chair Jerome Powell explained in a speech last year: "Reserves are the safest and most liquid asset in the financial system, and only the Fed can create them. The adequate provision of reserves is essential to the safety and soundness of our banking system, the resilience and efficiency of our payments system, and ultimately the stability of our economy."5 Our provision of reserves has broader and important benefits beyond monetary policy implementation. If banks don't have enough reserves, the payment system suffers, because it gives them an incentive to economize on their liquidity by slowing down their outgoing payments, leading to bottlenecks and stresses in funding markets. And, as we know, during stress if banks do not have enough reserves when depositors ask for withdrawals, panic can ensue. These aren't theoretical problems, which is why we have regulations that support sound liquidity risk management, and reserves play an important role in banks' portfolios of high-quality liquid assets (HQLA). The indispensable benefits of the Fed's reserve provision need to be at the forefront of any discussion about our balance sheet. Furthermore, creating reserves is costless to the Fed. The Fed pays interest on reserves but also receives interest on the other side of the balance sheet, which is largely in the form of Treasury securities.6 All the Fed's excess earnings go back to the taxpayer.7 Implementing Monetary Policy Efficiently and Effectively Let me now turn to efficient and effective monetary policy implementation. In keeping with our commitment to effective implementation, after substantially shrinking the balance sheet for a couple of years, the Fed is now slowly growing our balance sheet to keep up with demand for our liabilities. Over the many decades since our creation, we typically have grown our balance sheet through gradual purchases of Treasury securities, to ensure we continue to meet demand for our liabilities as the economy grows, consistent with our monetary policy implementation regime. Currently, the additions to the Fed's balance sheet are incremental, and we are buying Treasury bills. Others have explained our reserve management purchases, so I will not repeat that here.8 Instead, I will get straight to a discussion on how I see monetary policy implementation today as efficient and effective. Effective monetary policy implementation means that the federal funds rate, as well as other short-term interest rates such as repo rates, should trade near the rate the Fed pays on reserve balances. The current regime has achieved that for many years. Effective policy implementation also supports smooth market functioning. On the question of efficiency, Dallas Fed President Lorie Logan has discussed how monetary policy arrangements can minimize an economic cost associated with holding money, leaning on a principle put forth by economist Milton Friedman.9 In judging whether monetary policy is efficient, this approach uses the criterion of whether the opportunity cost to banks of holding reserves is close to the central bank's cost of supplying reserves. This is, in fact, the case right now. When this convergence of rates occurs, banks do not have a return-based incentive to economize on reserves.10 And because banks receive an interest rate on reserves that reflects safe asset status, banks are also not gaining excessive returns on holding reserves, so they have no incentive to load up on reserve holdings at the expense of lending to businesses and households. The fact that current monetary policy implementation is abiding by the Friedman principle is a sign that it is efficient. Under normal circumstances, this is a good place to be, but, of course, there are times when money market rates may trade more substantially below the IORB rate. Monetary policy implementation can remain effective in such conditions because we have a floor tool: overnight reverse repo operations, supporting rate control at the bottom of the target range. The footprint of reserve scarcity Some people believe that we should return to a scarce reserves regime, rather than an ample one. That policy would mean a smaller balance sheet, but it would not reduce the Fed's footprint in the market, given the degree of regulation and intervention that would be needed to operate this regime.11 Moreover, as I noted, there is no net cost to providing reserves, and making a free good scarce makes little economic sense.12 I will return to this topic in a bit, when I discuss attempting to implement monetary policy with minimally ample reserves. The footprint of balance sheet duration Some people argue that the Fed's footprint is too big in the sense that the duration of our portfolio is longer than that of Treasury securities held by the public and, thus, that we are putting downward pressure on long-term rates.13 As I mentioned earlier, much of our current longer-term asset portfolio was accumulated in dire circumstances when short-term rates were near zero and more accommodation was needed. Concerns about the duration or the composition of our asset portfolio need to be differentiated from concerns about the size of the balance sheet. In my judgment, the Treasury should determine the maturity composition of debt held by the public, and in normal times, our balance sheet should mirror the maturity distribution of outstanding issuance to the extent possible, thus ha