Bill Nelson on the Future of the Fed's Balance Sheet - Macro Musings with David Beckworth Recap

Podcast: Macro Musings with David Beckworth

Published: 2026-03-23

Duration: 3332

Guests: Bill Nelson

What Happened

Bill Nelson, Chief Research Officer and Chief Economist at the Bank Policy Institute, discusses the current state and future prospects of the Federal Reserve's balance sheet. He highlights the significant reduction of the Fed's balance sheet from $8.9 trillion to $6.5 trillion, marking the conclusion of Quantitative Tightening. Despite this reduction, Nelson points out the persistent high level of reserves, illustrating the Quantitative Easing (QE) ratchet effect, where it's harder to decrease reserves than to increase them.

Nelson explains that the structural demand for reserves has substantially increased over time due to bank liquidity regulations and monetary policy interactions. He details how these regulations, such as the liquidity coverage ratio, influence banks' reserve balances and mentions Vice Chair Bowman's scope for reforming these requirements. Nelson also discusses the role of the discount window in improving liquidity assessments and the stigma banks face when borrowing from it.

Nelson provides insights into his congressional testimony where he advocated for a reduction of the Fed's balance sheet. He argues that maintaining a large balance sheet poses political economy costs and risks to the Fed's independence. He shares that a large balance sheet can impact market and price discovery, particularly in the interbank overnight unsecured lending market.

The BPI's Bank Treasurers Survey revealed that risk management is the primary reason banks hold reserves, followed by regulatory compliance. The survey includes large banks and shows a significant reduction in reserve balances, exemplified by JPMorgan Chase's decrease from $400 billion in 2023 to $100 billion in 2025. Nelson suggests using temporary open market operations to manage fluctuations in the Treasury General Account.

Nelson addresses the Fed's profitability, noting its significant operating losses, with $200 billion in losses last year. He believes QE was intended to take on interest rate risk rather than simply create reserves, criticizing the Fed's lack of consideration for interest rate risk in recent transcripts. Nelson proposes using a term deposit facility to create appropriate incentives for reserve management.

He concludes by reflecting on the global trend of central banks reconsidering large balance sheets and floor systems. Nelson notes that many central banks are opting for smaller balance sheets, contrasting with Governor Waller's argument that maintaining large reserve balances is costless for the Fed. Nelson warns against the potential political uses of a large balance sheet, which could threaten the Fed's independence.

Key Insights

• The Fed's balance sheet has been reduced from $8.9 trillion to $6.5 trillion, ending Quantitative Tightening, yet reserves remain high due to the QE ratchet effect.
• The structural demand for reserves has increased significantly over the years, driven by bank liquidity regulations and interactions with monetary policy.
• Bill Nelson argues that large balance sheets pose political economy costs and risks to the Fed's independence, potentially impacting market and price discovery.
• The Fed faced $200 billion in operating losses last year, and Nelson criticizes the lack of consideration for interest rate risk in QE's implementation.