By Michael S. Derby
(Reuters) – U.S. Treasury Secretary Scott Bessent said on Tuesday the Federal Reserve’s system of managing interest rates was in trouble and needed to be simplified.
“We’ve gotten to this point where monetary policy has become very complicated” and the U.S. central bank should “simplify things,” Bessent said in an interview with CNBC.
“The Fed has brought us into a new regime, and what’s called an abundant reserves regime. And it looks like it might unravel a little bit here in terms of whether ‘reserves are actually sufficient,'” Bessent said.
The Treasury secretary did not say what he meant by fraying.
The Fed has and continues to face difficult money market conditions related to how it manages its $6.56 trillion balance sheet and liquidity levels in the financial system.
At the Fed’s latest policy meeting, officials announced they would halt the contraction of the central bank’s overall balance sheet in early December. They did so as liquidity in financial markets heading into the late-October policy meeting tightened enough to make it harder to control the federal funds rate, the Fed’s main tool for achieving its inflation and employment goals.
The turmoil was such that it caused eligible financial firms to borrow considerable amounts of cash from the Fed through its Permanent Repo Facility, a tool used to cap short-term interest rates. There have also been intermittent and large inflows of liquidity into the Fed’s repo tool, which is used to set a floor under money market rates.
CRITICISM OF THE FED’S BALANCE SHEET
Bessent is a persistent critic of the Fed, who has expressed particular concern about its large balance sheet, which is mostly filled with trillions in bonds purchased largely to stabilize financial markets and stimulate the economy.
The size of the footprint, at least in dollar terms, is seen by Bessent and others, including some at the Fed, as a distortion of market price levels. Concerns have also been raised about the Fed’s complex way of managing rates, which relies on liquidity facilities and eschews the highly managed system it used before the financial crisis that began nearly 20 years ago.
“A large balance sheet increases the Fed’s footprint in financial markets, distorts the price of duration and the slope of the yield curve, and potentially blurs the line between monetary policy and fiscal policy,” Kansas City Fed President Jeffrey Schmid said in a Nov. 14 speech.
Others have lamented that liquidity management in the current system has led the Fed to pay out substantial sums to financial institutions. This approach transformed the Fed from an institution that had made substantial profits to one that currently runs a $240 billion deficit, even though those losses have no impact on its ability to operate.
