Each part of the federal government tries to grow bigger and more influential at the nation's expense. The Federal Reserve is no different. Mission creep adds power and payroll. The Fed also has unlimited spending power and a false mystique of success.
The result is a multibillion-dollar building renovation, hundreds of big-government economists on the payroll, and a $6.8 trillion balance sheet, one-third larger than second-place JPMorgan.
Recent remarks by Fed Gov. Michael Barr defended the central bank's size, arguing that a bigger Fed makes banks more resilient, helps money markets function, and improves the stability of the financial system. In reality, the Fed's massive balance sheet does the opposite.
It puts a government agency in the driver seat on bond, repo and interbank markets, blocking innovation. The Fed has lost hundreds of billions on bad bond bets while becoming entwined in fiscal policy, destroying the interbank market, condoning the debasement of the dollar, and slowing progress on stablecoins and digital payment systems.
Chairman Kevin Warsh has correctly advocated regime change, including shrinking the Fed's balance sheet to allow price signals to work and competitive markets to form. Treasury Secretary Scott Bessent has highlighted the central bank's harm to affordability and income inequality.
By spending trillions of dollars in the 2010s and during the Biden administration, the Fed channeled capital to long-duration bonds at the expense of small businesses and working capital.
Additions to the Fed's powers during the 2008 financial crisis allowed it to buy bonds and pay interest to banks without limit, injecting it deeply into fiscal policy and the explosion of national debt.
Its antiquated economic models have allowed wide swings in inflation and deflation while poor regulatory policy contributed to bank failures such as Silicon Valley Bank.
Shrinking the balance sheet would lay the groundwork for lower interest rates. Banks would be able to innovate to meet liquidity requirements, whereas the current ample-reserves system locks them into dependency on the Fed and its bond portfolio.
Banks have multiple options and would invent more if the Fed stopped dominating. Extricating the Fed from fiscal policy would allow it to focus on price stability rather than the confusing promise of ample reserves.
Changing direction on the balance sheet would build market confidence in the long-term value of the dollar, the critical path to price stability and lower bond yields.
