Warsh may want a smaller Fed balance sheet, but that's hard to achieve

Core Viewpoint - Kevin Warsh, nominated to lead the Federal Reserve, may advocate for a smaller central bank balance sheet, but achieving this will require significant changes to the financial system, which may not be feasible [1][4]. Group 1: Federal Reserve's Balance Sheet - The current monetary policy framework relies on the banking system maintaining large amounts of liquidity, which constrains the Federal Reserve's ability to reduce its balance sheet without impacting money markets [2][3]. - Analysts from BMO Capital Markets indicate that a smaller Federal Reserve presence in financial markets is not straightforward and would necessitate regulatory reforms to decrease banks' demand for reserves, a process that could take several quarters [4]. - Economists Cecchetti and Schoenholtz highlight that a large central bank balance sheet facilitates undesirable government financing and can disrupt financial markets, suggesting that significant balance sheet reduction could lead to increased volatility in short-term markets [4]. Group 2: Kevin Warsh's Background and Views - Kevin Warsh, appointed by the Trump administration to succeed Jerome Powell, has been a long-time critic of the Federal Reserve's balance sheet policies, particularly regarding its use of bond and cash holdings as policy tools [5]. - The Federal Reserve's balance sheet has expanded dramatically due to aggressive bond purchases during the financial crisis and the COVID-19 pandemic, peaking at $9 trillion in spring 2022, with previous contractions failing to return to pre-crisis levels [6].