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# Fed 4: Two balance sheet reductions in 2017 and 2022 ## Kevin Warsh is preparing to [shrink balance sheets + cut interest rates] The possible actions to reduc

2026-07-19·x-repost-20260719-164504

Fed 4: Two balance sheet reductions in 2017 and 2022 ## Kevin Warsh is preparing to [shrink balance sheets + cut interest rates] The possible actions to reduce the balance sheet are nothing more than: 1. Not renewing the balance sheet upon maturity; 2. Directly selling long-term bonds; 3. Selling long-term bonds and buying short-term bonds; 4.

Reducing reserves. These actions may be a combination. Let’s talk about his possible “interest rate cut” model. ## We first need to take a look at the situation of federal interest rates during the past two balance sheet reduction processes: The first balance sheet reduction was from October 2017 to September 2019.

In fact, starting in 2015, the Federal Reserve has already ended its zero interest rate policy, increasing it from 0 to about 1.25%. After entering into the official balance sheet reduction, the interest rate increased for the second time, reaching the current peak of 2.5%.

But what is interesting is that before the epidemic, just as Trump began to raise the trade war sword against China in 2019, the Federal Reserve had already begun to cut interest rates, lowering the interest rate to about 1.5%.

In the past few months of 2019, although the Federal Reserve was still shrinking its balance sheet, it had gradually reduced its pace of shrinking its balance sheet. Generally speaking, they are coordinated. It is not considered that balance sheet reduction and interest rate cuts are completely inverse combinations.

The second balance sheet reduction will be from mid-2022 to the end of 2025. Just like the first time, the Fed had already started the process of raising interest rates before shrinking its balance sheet, until it reached a peak of around 5.5% in July 2023.

After entering September 2024, the situation began to be different, inflation data began to be significantly controlled, and the Federal Reserve began to cut interest rates, all the way to about 3.5% by the end of 2025.

Just like the first time, before the interest rate cut in September 2024, the Fed's monthly balance sheet shrinkage limit has been rapidly reduced from US$95 billion to US$60 billion, basically entering the deceleration stage. So, Generally speaking, it is only possible to cooperate with the interest rate cut policy when it is nearing the final stage.

The real process of shrinking the balance sheet is actually mostly completed during the process of raising interest rates. ## Here we want to talk about how the Federal Reserve "cuts" and "raises" interest rates. If the Fed does not directly buy and sell Treasury bonds in the secondary market, it will not directly affect Treasury bond yields.

The Federal Reserve mainly completes interest rate transmission through overnight inter-bank lending rates, which is what we usually call "federal interest rates." If the overnight dismantling rate drops, the fundamental capital costs of commercial banks will decrease.

In order to compete in the market, they will soon offer a lower loan interest rate to win more customers and business volume. At the same time, all short-term capital asset allocations of financial institutions (mainly short-term government bonds) will be repriced around this "fundamental cost".

The process is as follows: If the capital cost of taking money from the central bank is low, then financial institutions will use the money to "purchase" short-term government bonds that still have higher yields on the market.

Once there are more buyers, the market price of short-term government bonds will rise, and the yield on the government bonds embedded in them will drop until they are unprofitable. This is the federal interest rate - The transmission process of short-term government bond yields.

The short-term Treasury yield ≈ the average of the market’s expected federal funds rate over the coming period + a small liquidity premium. Therefore, interest rate cut expectations or actions are immediately reflected in short-term yields. As for long-term government bond yields, it is difficult to have a very direct impact.

For long-term Treasury bonds, long-term economic performance, long-term risk premium discount, and long-term Federal Reserve policy are affected by these factors. If the Fed wants to affect the yields on long-term Treasury bonds, the only sure and effective way is to directly buy and sell long-term Treasury bonds with real money.

## The reserve issue may be the fundamental problem: According to Regulation D of the Federal Reserve Act, the Federal Reserve has statutory reserve requirements for commercial banks, but this requirement has been significantly relaxed historically. In response to the epidemic in 2020, the statutory reserve ratio is 0.

At the beginning of 2007, the excess reserves of the U.S. commercial banking system were only US$1.7 billion, and the total reserves were approximately US$11 billion. However, the Federal Reserve has historically been a union of 12 private banks. The Federal Reserve’s capital mainly comes from the equity subscribed by its member banks. .

Of course, this is also considered a reserve fund, but this proportion is too small to serve as a reserve fund. The current huge reserves actually come from the Federal Reserve's direct purchase of Treasury bonds and MBS from commercial banks. The Federal Reserve does not need to pay cash.

It only needs to enter a series of numbers into the corresponding commercial bank's reserve account and include them in the corresponding deposits, which is the Federal Reserve's reserves. At present, this reserve fund is already excessively sufficient.

Under the current [adequate reserves] framework, the Federal Reserve adjusts central bank interest rates, especially the interest rate on reserve balances (IORB) and the overnight reverse repurchase rate/inter-bank lending rate (ON RRP).

Through the decline of these interest rates, the federal interest rate is guided to move closer to the interest rate space that the Fed wants.

Under the [limited reserve] framework advocated by Wash, The Fed no longer wants to hold excessive reserves to "control assets", but hopes to adjust the supply of reserves through open market operations "when necessary" (mainly buying and selling short-term Treasury bonds), thereby affecting the federal funds rate.

## Here we can begin to mention what Wash really wants: He believes that the excessive inflation of the Federal Reserve caused by QE after 2008 is abnormal, and these "excess" liabilities are mainly concentrated in "excessive" sufficient reserves, and the "excess" assets are mainly concentrated in long-term government bonds.

He hopes to shrink the balance sheet by cutting off excessive and sufficient reserves, and he also hopes to cut off excessive and sufficient reserves by shrinking the balance sheet. These two goals are fully consistent. As for how to reduce it and whether it can be reduced, don’t ask yet. Wash was also worried.

Full text

# Fed 4: Two balance sheet reductions in 2017 and 2022 ## Kevin Warsh is preparing to [shrink balance sheets + cut interest rates] The possible actions to reduc

# Fed 4: Two balance sheet reductions in 2017 and 2022 ## Kevin Warsh is preparing to [shrink balance sheets + cut interest rates] The possible actions to reduce the balance sheet are nothing more than: 1. Not renewing the balance sheet upon maturity; 2. Directly selling long-term bonds; 3. Selling long-term bonds and buying short-term bonds; 4. Reducing reserves. These actions may be a combination. Let’s talk about his possible “interest rate cut” model. ## We first need to take a look at the situation of federal interest rates during the past two balance sheet reduction processes: The first balance sheet reduction was from October 2017 to September 2019. In fact, starting in 2015, the Federal Reserve has already ended its zero interest rate policy, increasing it from 0 to about 1.25%. After entering into the official balance sheet reduction, the interest rate increased for the second time, reaching the current peak of 2.5%. But what is interesting is that before the epidemic, just as Trump began to raise the trade war sword against China in 2019, the Federal Reserve had already begun to cut interest rates, lowering the interest rate to about 1.5%. In the past few months of 2019, although the Federal Reserve was still shrinking its balance sheet, it had gradually reduced its pace of shrinking its balance sheet. Generally speaking, they are coordinated. It is not considered that balance sheet reduction and interest rate cuts are completely inverse combinations. The second balance sheet reduction will be from mid-2022 to the end of 2025. Just like the first time, the Fed had already started the process of raising interest rates before shrinking its balance sheet, until it reached a peak of around 5.5% in July 2023. After entering September 2024, the situation began to be different, inflation data began to be significantly controlled, and the Federal Reserve began to cut interest rates, all the way to about 3.5% by the end of 2025. Just like the first time, before the interest rate cut in September 2024, the Fed's monthly balance sheet shrinkage limit has been rapidly reduced from US$95 billion to US$60 billion, basically entering the deceleration stage. So, Generally speaking, it is only possible to cooperate with the interest rate cut policy when it is nearing the final stage. The real process of shrinking the balance sheet is actually mostly completed during the process of raising interest rates. ## Here we want to talk about how the Federal Reserve "cuts" and "raises" interest rates. If the Fed does not directly buy and sell Treasury bonds in the secondary market, it will not directly affect Treasury bond yields. The Federal Reserve mainly completes interest rate transmission through overnight inter-bank lending rates, which is what we usually call "federal interest rates." If the overnight dismantling rate drops, the fundamental capital costs of commercial banks will decrease. In order to compete in the market, they will soon offer a lower loan interest rate to win more customers and business volume. At the same time, all short-term capital asset allocations of financial institutions (mainly short-term government bonds) will be repriced around this "fundamental cost". The process is as follows: If the capital cost of taking money from the central bank is low, then financial institutions will use the money to "purchase" short-term government bonds that still have higher yields on the market. Once there are more buyers, the market price of short-term government bonds will rise, and the yield on the government bonds embedded in them will drop until they are unprofitable. This is the federal interest rate - The transmission process of short-term government bond yields. The short-term Treasury yield ≈ the average of the market’s expected federal funds rate over the coming period + a small liquidity premium. Therefore, interest rate cut expectations or actions are immediately reflected in short-term yields. As for long-term government bond yields, it is difficult to have a very direct impact. For long-term Treasury bonds, long-term economic performance, long-term risk premium discount, and long-term Federal Reserve policy are affected by these factors. If the Fed wants to affect the yields on long-term Treasury bonds, the only sure and effective way is to directly buy and sell long-term Treasury bonds with real money. ## The reserve issue may be the fundamental problem: According to Regulation D of the Federal Reserve Act, the Federal Reserve has statutory reserve requirements for commercial banks, but this requirement has been significantly relaxed historically. In response to the epidemic in 2020, the statutory reserve ratio is 0. At the beginning of 2007, the excess reserves of the U.S. commercial banking system were only US$1.7 billion, and the total reserves were approximately US$11 billion. However, the Federal Reserve has historically been a union of 12 private banks. The Federal Reserve’s capital mainly comes from the equity subscribed by its member banks. . Of course, this is also considered a reserve fund, but this proportion is too small to serve as a reserve fund. The current huge reserves actually come from the Federal Reserve's direct purchase of Treasury bonds and MBS from commercial banks. The Federal Reserve does not need to pay cash. It only needs to enter a series of numbers into the corresponding commercial bank's reserve account and include them in the corresponding deposits, which is the Federal Reserve's reserves. At present, this reserve fund is already excessively sufficient. Under the current [adequate reserves] framework, the Federal Reserve adjusts central bank interest rates, especially the interest rate on reserve balances (IORB) and the overnight reverse repurchase rate/inter-bank lending rate (ON RRP). Through the decline of these interest rates, the federal interest rate is guided to move closer to the interest rate space that the Fed wants. Under the [limited reserve] framework advocated by Wash, The Fed no longer wants to hold excessive reserves to "control assets", but hopes to adjust the supply of reserves through open market operations "when necessary" (mainly buying and selling short-term Treasury bonds), thereby affecting the federal funds rate. ## Here we can begin to mention what Wash really wants: He believes that the excessive inflation of the Federal Reserve caused by QE after 2008 is abnormal, and these "excess" liabilities are mainly concentrated in "excessive" sufficient reserves, and the "excess" assets are mainly concentrated in long-term government bonds. He hopes to shrink the balance sheet by cutting off excessive and sufficient reserves, and he also hopes to cut off excessive and sufficient reserves by shrinking the balance sheet. These two goals are fully consistent. As for how to reduce it and whether it can be reduced, don’t ask yet. Wash was also worried.

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