Dallas Federal Reserve President Lorie Logan detailed the potential pathways and options for the U.S. central bank to reduce the size of its balance sheet in a speech on Thursday. She noted that the current system is functioning well but indicated that the Fed could further advance balance sheet reduction through measures such as adjusting regulatory requirements.
The existing framework operates effectively, yet there remains scope for reducing the balance sheet. Logan stated that the Fed's current system for managing financial liquidity is designed to provide an "ample" level of reserves, which she described as "efficient and effective." However, she also pointed out that under the current system, there are multiple ways to help decrease the Fed's asset holdings, many of which involve changes to the rules governing how financial institutions manage their cash reserves.
Adjusting regulations could lower the demand for reserves. Logan highlighted that recent internal and external Fed research suggests that by modifying regulations to encourage banks to hold lower levels of reserves, the Fed could further shrink its balance sheet without altering the existing "ample reserves" framework. She expressed agreement with this approach and mentioned that the Fed is currently working to make reserve management "more efficient" during periods of stress.
Inefficient use of reserves should be avoided. Logan also observed that some liquidity rules, while increasing reserves on paper, do not genuinely enhance the financial system's safety because banks are often reluctant to utilize these reserves during a crisis. She commented on this, stating, "This is an inefficient use of the Federal Reserve's balance sheet, and we can certainly avoid this situation."
The context and outlook for balance sheet reduction. It is noteworthy that Logan delivered these remarks at a time when the Fed is actually in a phase of expanding its balance sheet. During the pandemic, the Fed's balance sheet surged to a historic peak of approximately $9 trillion. Although quantitative tightening (QT) was subsequently initiated, it was paused by the end of 2025 due to impacts on the stability of money market rates, and the Fed shifted to purchasing short-term Treasury bills to supplement market liquidity.
Fed Governor Miran had previously stated that there is a realistic path for the Fed's balance sheet to be reduced by $1 trillion to $2 trillion, but this process "could take several years."
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