Federal Reserve New York official: Current interest rate management tools can address the decline in reserve demand.

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Officials responsible for implementing monetary policy at the New York Fed said the Federal Reserve's current toolbox for interest rate control is sufficient to cope with declining demand for reserves, emphasizing that the framework has an outstanding track record of management under various economic and financial conditions.

Roberto Perli, manager of the New York Fed's open market account, stated in a speech at a meeting hosted by the Atlanta Fed on Tuesday that if changes in the financial system allow banks to hold fewer reserves, the Fed's current ample-reserve implementation framework can fully respond to balance sheet reduction.

He said, "For any implementation framework, the key criterion is whether it can effectively control interest rates under all sorts of economic and financial conditions—in this regard, our framework has an excellent historical record."

Meanwhile, Perli noted that the Fed will flexibly adjust the pace of Treasury purchases depending on market conditions.

These remarks come as debates about the future trajectory of the Fed’s balance sheet are intensifying. Walsh, who is about to become Fed chairman, has long criticized the Fed's large-scale bond purchases, arguing that the scale of the Fed's market intervention is too large and distorts pricing, and advocates shrinking the overall size of the balance sheet.

Currently, the main concern regarding the Fed’s balance sheet is: the existing toolbox relies heavily on the scale of reserves, which objectively limits the space for balance sheet reduction and might make it difficult for the Fed to effectively control the federal funds rate while sharply reducing its holdings.

Space for balance sheet reduction depends on whether reserve demand can 'shift left'

Perli acknowledged that a decline in reserve demand would create conditions for further balance sheet reduction. He said, "There are many catalysts for a leftward shift in reserve demand, but given current discussions, a reasonable possibility is potential future adjustments in bank regulatory liquidity requirements."

This statement points directly to a view—if regulators relax liquidity rules, the amount of reserves banks need to hold will accordingly decrease, and the Fed could further reduce its asset holdings as a result.

The Fed’s balance sheet expanded sharply during the COVID-19 pandemic, peaking at about $9 trillion in mid-2022, then gradually falling to the current $6.7 trillion. Walsh, soon to take over the Fed, believes this scale is still too large and argues that shrinking the balance sheet will create more room for short-term rate targets to move downward.

Fed insiders pointed out that providing reserves to the financial system has no cost in itself, and given the current framework’s highly precise management of monetary policy execution, the scale of Fed holdings is not a substantive issue.

Treasury purchase pace will remain flexible

Regarding Treasury purchase operations, Perli stated that the Fed will flexibly adjust the pace of Reserve Management Purchases (RMP) based on market conditions. He made it clear, "We are always ready to increase or decrease the purchase pace of RMP as needed."

The Fed launched its Treasury purchase plan at the end of last year, aiming to rebuild market liquidity after years of balance sheet reduction. Currently, the purchase volume under this plan has dropped from an initial $40 billion per month to the current $10 billion per month.

Perli said the future purchase pace will depend on market conditions, meaning the Fed will not adopt a fixed path for this operation, but will retain flexibility for adjustment at any time.

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