Key facts
- The Brookings paper suggests shrinking the Fed's balance sheet to $4.5 trillion from $6.8 trillion.
- Proposed changes include overhauling liquidity tools and allowing banks to hold less cash.
- The paper advocates for an "Elastic Reserves" system to replace the current "ample reserves" system.
- Interest paid to banks could fall by roughly two-thirds, according to the paper.
- The proposed level of reserves in the financial system could fall from $3 trillion to $1 trillion.
A paper published by the Brookings Institution suggests the Federal Reserve could significantly shrink its balance sheet by implementing a new system of "Elastic Reserves" and adjusting bank reserve requirements. The proposed changes could reduce the Fed's overall holdings from $6.8 trillion to approximately $4.5 trillion, with financial system reserves falling from around $3 trillion to $1 trillion. The paper's author, Chris Hughes, argues that this is an opportune moment for such reforms, given the current Fed Chairman Kevin Warsh's stated desire for a smaller balance sheet and his establishment of a task force to explore this objective. Hughes noted that the Fed's footprint as a share of GDP would be smaller than at any point since 2008, and interest paid to banks could decrease by approximately two-thirds.