MNI: Fed's Hammack Prefers Smaller Balance Sheet

Federal Reserve Bank of Cleveland President Beth Hammack on Wednesday urged the FOMC to continue reducing its balance sheet and trimming reserves to an amount that may require occasional intervention from the central bank to keep overnight rates under control.    

"In general, if a scarce reserves regime requires regular intervention in the market and an abundant reserves regime requires no intervention, then an ample reserves regime that requires occasional intervention strikes me as about right. This may be an area worthy of discussion by the FOMC," she said in remarks prepared for the Money Marketeers of New York University in New York. 

"Whatever the tactics the Committee chooses to keep reserves ample, some volatility in overnight markets may not be such a wild thing," she said. 

While Hammack said she supported the FOMC's March decision to slow QT further, runoffs could have continued for the time being as reserves remained abundant, she said. 

"I expect that by slowing the pace of runoff, we will be able to let the process continue for longer. In particular, I interpret this slower pace to emphatically not be a signal of a permanently larger balance sheet than would have been the case without a slowdown," she said. 

INTERVENTIONS

How much longer runoff should continue depends on a number of factors, she said. One of those is how big a buffer the Fed should maintain over the "ample" amount. If reserves fall below ample, then small fluctuations in the supply of and demand for reserves could increase volatility in overnight money markets, potentially dramatically, she said. 

Hammack said she would favor a smaller buffer as the Fed has a repo market backstop, the standing repo facility, to help dampen volatility. The Fed should look at strengthening and expanding this tool, she added. 

At times, the Fed may still need to intervene by purchasing assets, even if reserves are more than ample, and it could be helpful for the central bank to clearly communicate that such "market-functioning actions" differ from policy actions, she said. 

"While it is not clear that separation between market functioning purchases and policy purchases is necessary in theory, in practice there could be communications and coordination benefits from this type of approach to segmenting the balance sheet," she said.