Fed's Williams Sees Future Balance Sheet Size Starting at $2 Trillion

By Katy Burne Features Dow Jones Newswires

Federal Reserve Bank of San Francisco President John Williams said he could see the U.S. central bank's balance sheet settling somewhere above $2 trillion, concurring with several estimates that have put the figure at least that high in the absence of a specific prediction from the Fed.

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Mr. Williams's comments Friday come as Fed officials prepare their strategy for shrinking the central bank's $4.5 trillion portfolio of Treasury and mortgage bonds. One key question is just how much smaller those holdings ultimately should be.

The central banker said that even after the Fed has reduced its giant bond portfolio, the balance sheet likely would remain large enough to accommodate the myriad ways markets have changed since the financial crisis, during an audience question-and-answer session after a speech in New York.

Mr. Williams said the Fed has been talking internally about the optimal way to exit its postcrisis monetary policy, including its enormous balance sheet, since as early as 2011. Fed officials have signaled in recent policy meeting minutes that they want to start shrinking the portfolio later this year, but not where they want it to end up or how they want to get there.

Starting this year "makes sense to me," given unemployment is now below 4.5% and inflation is close to the Fed's 2% goal. "We need to get monetary policy back to more normal levels...both in terms of our balance sheet and in terms of interest rates," Mr. Williams told the audience.

The Fed's interest-rate-setting committee has said it wants to bring the balance sheet down to a size that, at a minimum, would still allow it conduct monetary policy effectively. Whatever that size is, Mr. Williams said, it should be "significantly smaller" than its current elevated level.

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Some economists, including former Fed Chairman Ben Bernanke, have argued there are merits to keeping a large balance sheet, in support of various efforts that would provide high-quality assets to banks in times of turmoil and bolster financial stability.

In an interview with CNBC on Monday, Mr. Bernanke said there also was "some evidence a larger balance sheet makes monetary policy more effective, that it transmits interest rates into the economy more effectively." He predicted the balance sheet would end up at $2.3 trillion to $2.8 trillion.

Separately, in an April blog post for the Brookings Institution, where he is a fellow, Mr. Bernanke wrote: "It's not unreasonable to argue that the optimal size of the Fed's balance is currently greater than $2.5 trillion and may reach $4 trillion or more over the next decade."

Mr. Williams said the Fed has decided to reduce it meaningfully. The rate-setting committee "has weighed the pros and cons... and has decided that we are going to reduce the size of the balance sheet from its very elevated levels gradually," he said.

The amount of money, called reserves, that banks would leave on deposit at the Fed in the future policy framework remains an open question. Mr. Williams said the amount of preferred reserves "could be on the order of hundreds of billions of dollars," down from current levels around $2 trillion. Before the crisis, reserve balances totaled around $10 billion.

Mr. Williams said the preferred amount of reserves could change depending on alterations to federal banking regulations under the new administration, which has been reviewing them. Those factors make it hard to know what the ideal amount of excess reserves, above regulatory requirements, should be, he said.

The $2 trillion or higher figure would be enough to back the amount of currency in circulation, currently around $1.5 trillion and likely to grow, as well as at least $500 billion in excess reserves.

"The size of the balance sheet will be moving up with currency every year," he told reporters. "A number...which is the total balance sheet is $2 trillion, the first digit is a 2, that sounds right."

He added: "I do view that as significantly lower than the over $4 trillion that we have today."

Top Wall Street economists predict the total will need to stay at least in the trillions of dollars to support changing financial conditions. Before the financial crisis, the Fed's balance sheet was around $900 billion. David Mericle, a vice president with the economics team at Goldman Sachs Group Inc., sees it ending up in the ballpark of $2 trillion to $2.9 trillion, depending on how fast and what methods the Fed uses to shrink its holdings.

Write to Katy Burne at katy.burne@wsj.com

(END) Dow Jones Newswires

May 05, 2017 18:25 ET (22:25 GMT)