By David Beckworth

   About the author:  David Beckworth   is a senior research fellow with the Mercatus Center and host of the Macro Musings podcast. 

Federal Reserve chair nominee Kevin Warsh has called for "regime change" at the bank. His primary target: the bloated balance sheet.

At roughly $6.5 trillion -- about 22% of gross domestic product -- the balance sheet is historically large, even after several years of quantitative tightening. Warsh has said that it's far bigger than necessary for effective monetary policy.

He has also been blunt about the risks associated with such bloat: a larger footprint in financial markets, more exposure to political pressures, and a Fed that increasingly looks like a fiscal actor rather than a monetary one. None of this is especially controversial.

What is controversial is whether a Fed chair can do much about it. After all, we have seen three chairs and four rounds of quantitative easing since 2008. Each time, QE was framed as temporary but was never fully reversed. The balance sheet ratcheted up in crises and settled higher.

There is, however, a path forward for Warsh to overhaul the balance sheet, carefully and over several years.

First, it would need to make the discount window and standing repo operations -- the facilities from which banks can borrow from the Fed -- routine rather than exceptional. Banks are currently unwilling or unsure about using these tools, so they keep a large share of their deposits at the Fed in the form of bank reserves, which keeps the Fed's balance sheet large.

If Warsh wants to reduce banks' demand for reserves, he has to make borrowing from the Fed boring. That means redesigning the discount window so routine liquidity access is clearly separated from emergency lending, holding regular auctions to normalize its use, and expanding access to repo operations. If liquidity is always available at a predictable price, banks won't need massive deposits at the Fed "just in case." Reserves could decline.

Second, a Warsh Fed would need to neutralize swings in the government's checking account at the Fed. When tax receipts flow into the Treasury General Account, funds are pulled out of the banking system, reducing bank deposits at the Fed and vice versa. In other words, every dollar that moves into the TGA drains reserves from the banking system. Every dollar that leaves, the TGA puts them back.

These swings can be large and lead to sharp changes in the amount of money in the banking system and, therefore, in short-term interest rates. A big Fed balance sheet with abundant reserves is better protected against these fluctuations than a small one. Consequently, shrinking the balance sheet requires swings in the TGA be neutralized so rates remain anchored.

There are several ways to do this. Fed economist Annette Vissing-Jorgensen suggests backing the TGA with short-term Treasury bills held by the Fed and adjusting those holdings as the account rises and falls. Economist Bill Nelson proposes recycling TGA balances through the repo market, offsetting reserve drains and injections in real time. Both recognize Treasury cash management shouldn't be driving the size of the Fed's balance sheet.

The Fed should also make balance-sheet reduction easier by swapping long bonds for bills. It currently holds a large portfolio of long-duration Treasury securities. Letting those run off is slow, but selling them outright risks market disruption. A cleaner approach would be an automatic Treasury-Fed asset swap after QE ends, in which the Fed exchanges its long-term bonds for short-term Treasury bills.

Bills mature quickly and are easier to manage and simpler to wind down. Shrinking the balance sheet in this setup is mechanical rather than discretionary. An added benefit is that a bill-heavy portfolio would better match the Fed's short-term liabilities, reducing the duration mismatch that has produced recent operating losses and, with them, unwanted political attention.

Fourth, the Fed needs to reform its operating framework to stop the QE ratchet effect. When reserves are abundant for long periods, banks, supervisors, and markets come to view those elevated levels as normal and essential to smooth operations. Risk models, stress tests, and liquidity practices begin to assume that level of reserves is a baseline. The result is liquidity dependence on reserves, which makes balance-sheet reduction increasingly difficult each cycle. As a result, QE is never fully reversed.

One solution is to offer term deposits at the target federal-funds rate, while setting interest on reserves modestly below that rate and pricing its lending facilities modestly above it. Banks would still have access to liquidity when needed, but holding large overnight reserve balances would no longer be costless. Banks would economize on their reserve holdings and, in turn, depend less on reserves.

When QE ends, term deposits would roll off unless renewed, and the balance sheet would shrink by default. Sweden's central bank has substantially reduced its balance sheet with this demand-driven system.

The hardest part of this agenda isn't technical, but institutional. It requires buy-in from the Federal Open Market Committee and Treasury. Warsh needs to persuade them that a smaller balance sheet isn't a step backward, but a return to a more disciplined and resilient operating framework. Shrinking the balance sheet won't solve all the Fed's problems, but for a chair promising change, it is a good place to start.

Guest commentaries like this one are written by authors outside the Barron's newsroom. They reflect the perspective and opinions of the authors. Submit feedback and commentary pitches to ideas@barrons.com .

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

By David Beckworth

   About the author:  David Beckworth   is a senior research fellow with the Mercatus Center and host of the Macro Musings podcast. 

Federal Reserve chair nominee Kevin Warsh has called for "regime change" at the bank. His primary target: the bloated balance sheet.

At roughly $6.5 trillion -- about 22% of gross domestic product -- the balance sheet is historically large, even after several years of quantitative tightening. Warsh has said that it's far bigger than necessary for effective monetary policy.

He has also been blunt about the risks associated with such bloat: a larger footprint in financial markets, more exposure to political pressures, and a Fed that increasingly looks like a fiscal actor rather than a monetary one. None of this is especially controversial.

What is controversial is whether a Fed chair can do much about it. After all, we have seen three chairs and four rounds of quantitative easing since 2008. Each time, QE was framed as temporary but was never fully reversed. The balance sheet ratcheted up in crises and settled higher.

There is, however, a path forward for Warsh to overhaul the balance sheet, carefully and over several years.

First, it would need to make the discount window and standing repo operations -- the facilities from which banks can borrow from the Fed -- routine rather than exceptional. Banks are currently unwilling or unsure about using these tools, so they keep a large share of their deposits at the Fed in the form of bank reserves, which keeps the Fed's balance sheet large.

If Warsh wants to reduce banks' demand for reserves, he has to make borrowing from the Fed boring. That means redesigning the discount window so routine liquidity access is clearly separated from emergency lending, holding regular auctions to normalize its use, and expanding access to repo operations. If liquidity is always available at a predictable price, banks won't need massive deposits at the Fed "just in case." Reserves could decline.

Second, a Warsh Fed would need to neutralize swings in the government's checking account at the Fed. When tax receipts flow into the Treasury General Account, funds are pulled out of the banking system, reducing bank deposits at the Fed and vice versa. In other words, every dollar that moves into the TGA drains reserves from the banking system. Every dollar that leaves, the TGA puts them back.

These swings can be large and lead to sharp changes in the amount of money in the banking system and, therefore, in short-term interest rates. A big Fed balance sheet with abundant reserves is better protected against these fluctuations than a small one. Consequently, shrinking the balance sheet requires swings in the TGA be neutralized so rates remain anchored.

There are several ways to do this. Fed economist Annette Vissing-Jorgensen suggests backing the TGA with short-term Treasury bills held by the Fed and adjusting those holdings as the account rises and falls. Economist Bill Nelson proposes recycling TGA balances through the repo market, offsetting reserve drains and injections in real time. Both recognize Treasury cash management shouldn't be driving the size of the Fed's balance sheet.

The Fed should also make balance-sheet reduction easier by swapping long bonds for bills. It currently holds a large portfolio of long-duration Treasury securities. Letting those run off is slow, but selling them outright risks market disruption. A cleaner approach would be an automatic Treasury-Fed asset swap after QE ends, in which the Fed exchanges its long-term bonds for short-term Treasury bills.

Bills mature quickly and are easier to manage and simpler to wind down. Shrinking the balance sheet in this setup is mechanical rather than discretionary. An added benefit is that a bill-heavy portfolio would better match the Fed's short-term liabilities, reducing the duration mismatch that has produced recent operating losses and, with them, unwanted political attention.

Fourth, the Fed needs to reform its operating framework to stop the QE ratchet effect. When reserves are abundant for long periods, banks, supervisors, and markets come to view those elevated levels as normal and essential to smooth operations. Risk models, stress tests, and liquidity practices begin to assume that level of reserves is a baseline. The result is liquidity dependence on reserves, which makes balance-sheet reduction increasingly difficult each cycle. As a result, QE is never fully reversed.

One solution is to offer term deposits at the target federal-funds rate, while setting interest on reserves modestly below that rate and pricing its lending facilities modestly above it. Banks would still have access to liquidity when needed, but holding large overnight reserve balances would no longer be costless. Banks would economize on their reserve holdings and, in turn, depend less on reserves.

When QE ends, term deposits would roll off unless renewed, and the balance sheet would shrink by default. Sweden's central bank has substantially reduced its balance sheet with this demand-driven system.

The hardest part of this agenda isn't technical, but institutional. It requires buy-in from the Federal Open Market Committee and Treasury. Warsh needs to persuade them that a smaller balance sheet isn't a step backward, but a return to a more disciplined and resilient operating framework. Shrinking the balance sheet won't solve all the Fed's problems, but for a chair promising change, it is a good place to start.

Guest commentaries like this one are written by authors outside the Barron's newsroom. They reflect the perspective and opinions of the authors. Submit feedback and commentary pitches to ideas@barrons.com .

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

February 21, 2026 09:30 ET (14:30 GMT)

Copyright (c) 2026 Dow Jones & Company, Inc.