Warsh Favors Shrinking Fed's Balance Sheet?

[ryan.be...@gmail.com]

Hi all,

As many are aware, Kevin Warsh was nominated on Friday to replace Jay Powell as Chairman of the Federal Reserve. Among other policies he has advocated for has been a proactive "shrinking" of the Fed's balance sheet. By this, I assume him to mean he intends the Fed to hold fewer Treasuries and Agencies on its balance sheet.

Just thinking through the mechanics here, would an accelerated disposal of Treasury and/or Agency securities really "shrink" the Fed's balance sheet, in aggregate? I'm inclined to think it wouldn't, because selling down those holdings is ostensibly a reserve drain operation, and the Fed would have to add the reserves back to keep control of the funds rate, presumably by increasing the usage of Repos.

Checking to see if this is mechanically correct? And as far as implications go, while many believe it's likely to cause rates on the long end of the yield curve to move higher, I'm not as convinced. If anything, I could see the volatility of rates on the long end increasing, which causes its own problems. Somewhat similar to the impact we saw when the Fed starting winding down its Agency securities holdings.

Thoughts and feedback welcome.

[Ed Lane]

My paper attached 

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[Jay Mills]

Basically, shrinking the balance sheet mostly reshuffles who holds bonds. It doesn’t really tighten things unless reserves get scarce, and the Fed won’t allow that for long. The Fed controls short-term rates directly, and long-term rates depend more on investor behavior than on forcing discipline. If balance-sheet shrinkage ever caused serious problems, the Fed could just reverse it.

-Jason

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<The Warsh Paradox.pdf>

[Ed Lane]

Agreed

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From: Jay Mills <jasonmi...@gmail.com>
Sent: Monday, February 2, 2026 8:57 AM
To: Ed Lane <edc...@gmail.com>
Cc: ryan.be...@gmail.com <ryan.be...@gmail.com>; Modern Monetary Theory <modern-mone...@googlegroups.com>
Subject: Re: Warsh Favors Shrinking Fed's Balance Sheet?

 

[Jay Mills]

While listening to Odd Lots and some other criticisms - and I’m openly anti-Trump in every way possible - I do welcome the push for lower rates.  I’m not sure Trump has explained why he’s pushing it but Warsh has flip flopped in order to get the job and whatever gets us to a lower rate is welcome in my book.  

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