[House Hearing, 119 Congress]
[From the U.S. Government Publishing Office]
STRIKING THE RIGHT BALANCE SHEET
=======================================================================
HEARING
before the
TASK FORCE ON MONETARY POLICY, TREASURY
MARKET RESILIENCE, AND ECONOMIC PROSPERITY
of the
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINETEENTH CONGRESS
SECOND SESSION
__________
JANUARY 14, 2026
__________
Serial No. 119-52
Printed for the use of the Committee on Financial Services
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]
www.govinfo.gov
______
U.S. GOVERNMENT PUBLISHING OFFICE
63-859 PDF WASHINGTON : 2026
HOUSE COMMITTEE ON FINANCIAL SERVICES
FRENCH HILL, Arkansas, Chairman
BILL HUIZENGA, Michigan, Vice MAXINE WATERS, California, Ranking
Chairman Member
FRANK D. LUCAS, Oklahoma SYLVIA R. GARCIA, Texas, Vice
PETE SESSIONS, Texas Ranking Member
ANN WAGNER, Missouri NYDIA M. VELAZQUEZ, New York
ANDY BARR, Kentucky BRAD SHERMAN, California
ROGER WILLIAMS, Texas GREGORY W. MEEKS, New York
TOM EMMER, Minnesota DAVID SCOTT, Georgia
BARRY LOUDERMILK, Georgia STEPHEN F. LYNCH, Massachusetts
WARREN DAVIDSON, Ohio AL GREEN, Texas
JOHN W. ROSE, Tennessee EMANUEL CLEAVER, Missouri
BRYAN STEIL, Wisconsin JAMES A. HIMES, Connecticut
WILLIAM R. TIMMONS, IV, South BILL FOSTER, Illinois
Carolina JOYCE BEATTY, Ohio
MARLIN STUTZMAN, Indiana JUAN VARGAS, California
RALPH NORMAN, South Carolina JOSH GOTTHEIMER, New Jersey
DANIEL MEUSER, Pennsylvania VICENTE GONZALEZ, Texas
YOUNG KIM, California SEAN CASTEN, Illinois
BYRON DONALDS, Florida AYANNA PRESSLEY, Massachusetts
ANDREW R. GARBARINO, New York RASHIDA TLAIB, Michigan
SCOTT FITZGERALD, Wisconsin RITCHIE TORRES, New York
MIKE FLOOD, Nebraska NIKEMA WILLIAMS, Georgia
MICHAEL LAWLER, New York BRITTANY PETTERSEN, Colorado
MONICA DE LA CRUZ, Texas CLEO FIELDS, Louisiana
ANDREW OGLES, Tennessee JANELLE BYNUM, Oregon
ZACHARY NUNN, Iowa SAM LICCARDO, California
LISA McCLAIN, Michigan
MARIA SALAZAR, Florida
TROY DOWNING, Montana
MIKE HARIDOPOLOS, Florida
TIM MOORE, North Carolina
Ben Johnson, Staff Director
------
TASK FORCE ON MONETARY POLICY, TREASURY MARKET RESILIENCE,
AND ECONOMIC PROSPERITY
FRANK D. LUCAS, Oklahoma, Chairman
BILL HUIZENGA, Michigan JUAN VARGAS, California, Ranking
ANDY BARR, Kentucky Member
MARLIN STUTZMAN, Indiana BRAD SHERMAN, California
SCOTT FITZGERALD, Wisconsin JOSH GOTTHEIMER, New Jersey
MIKE FLOOD, Nebraska SEAN CASTEN, Illinois
MONICA DE LA CRUZ, Texas CLEO FIELDS, Louisiana
TROY DOWNING, Montana JANELLE BYNUM, Oregon
C O N T E N T S
----------
Wednesday, January 14, 2026
OPENING STATEMENTS
Page
Hon. Frank D. Lucas, Chairman of the Task Force on Monetary
Policy, Treasury Market Resilience, and Economic Prosperity, a
U.S. Representative from Oklahoma.............................. 1
Hon. Juan Vargas, Ranking Member of the Task Force on Monetary
Policy, Treasury Market Resilience, and Economic Prosperity, a
U.S. Representative from California............................ 2
STATEMENTS
Hon. French Hill, Chairman of the Committee on Financial
Services, a U.S. Representative From Arkansas.................. 3
WITNESSES
Dr. James A. Clouse, Senior Fellow, Andersen Institute for
Economics & Finance............................................ 4
Prepared Statement........................................... 7
Dr. Bill Nelson, Executive Vice President, Chief Economist and
Head of Research, Bank Policy Institute........................ 19
Prepared Statement........................................... 21
Dr. Allison Schrager, Senior Fellow, Manhattan Institute......... 34
Prepared Statement........................................... 37
Dr. William B. English, Eugene F. Williams, Jr., Professor of the
Practice, Yale School of Management............................ 43
Prepared Statement........................................... 45
APPENDIX
MATERIALS SUBMITTED FOR THE RECORD
RESPONSES TO QUESTIONS FOR THE RECORD
Written responses to questions for the record from Representative
Troy Downing...................................................
Dr. Bill Nelson.............................................. 80
STRIKING THE RIGHT BALANCE SHEET
----------
Wednesday, January 14, 2026
U.S. House of Representatives,
Subcommittee on Task Force On Monetary Policy,
Treasury Market Resilience, and Economic
Prosperity,
Committee on Financial Services,
Washington, DC.
The task force met, pursuant to notice, at 2:14 p.m., in
room 2128, Rayburn House Office Building, Hon. Frank D. Lucas
[chairman of the task force] presiding.
Present: Representatives Lucas, Huizenga, Fitzgerald,
Flood, De La Cruz, Downing, Vargas, Casten, Fields, and Bynum.
Also present: Representatives Hill, Waters, Green of Texas,
Foster, and Liccardo.
Chairman Lucas. The Task Force on Monetary Policy, Treasury
Market Resilience, and Economic Prosperity will come to order.
Without objection, the chair is authorized to declare a
recess of the committee at any time.
This hearing is entitled, ``Striking the Right Balance
Sheet.''
Without objection, all members will have 5 legislative days
within which to submit extraneous materials to the chair for
inclusion in the record.
I now recognize myself for 4 minutes for an opening
statement.
OPENING STATMENT OF HON. FRANK D. LUCAS, CHAIRMAN OF THE TASK
FORCE ON MONETARY POLICY, TREASURY MARKET RESILIENCE, AND
ECONOMIC PROSPERITY, A U.S. REPRESENTATIVE FROM OKLAHOMA
Welcome to the first task force hearing of 2026. Our focus
today is on the Federal Reserve's (Fed's) balance sheet, a
record of its assets and liabilities that demonstrate its
operations.
The Fed's balance sheet has undergone dramatic changes in
the last 15 years, growing from less than $1 trillion in 2008,
or 6 percent of gross domestic product (GDP), to almost $9
trillion in 2022, or 35 percent of GDP.
In 2008, the Fed moved from a quarter system to a floor
system, necessarily demanding an increase in the quality of
reserves on the balance sheet. Despite that change, the Fed has
continued to express the view that reserves should be at the
smallest levels consistent with the effective implementation of
monetary policy.
We have not always seen the Fed stick to that view, instead
using its balance sheet to provide economic stimulus, not
merely as a means to control rates. In 2008, the Fed engaged in
four rounds of large-scale asset purchases, or quantitative
easings (QEs), with its balance sheet standing at $6.5 trillion
today. Yet, the academic literature shows mixed results on the
effectiveness of QE at economic support.
While the jury is out on the benefits of QE, we do know
that it raises risks of inflation and market distortion. The
Fed should rely on conventional monetary policy tools under its
ample reserves regime and avoid market operations that may have
unintended and lasting consequences.
Additionally, the Fed should clearly articulate under what
conditions it uses the balance sheet for economic stimulus,
economic contraction, and policy implementation in the future.
This is particularly important now as the Fed engages in
reserve management purchases.
Finally, it may be tempting to allow the news of the day to
distract us from the purpose of today's hearing. I will
continue to emphasize that the independence of the Fed is
critical to ensuring it makes sound interest-rate decisions
that are essential to favorable economic outcomes. We will do
well to remember that decisions made now have lasting
implications, not just for the next Fed chair but for the next
10 Fed chairs.
That said, let us focus our discussion today on the proper
use of the balance sheet and its impact on monetary policy
implementation and Treasury market functioning.
I yield back.
I now recognize the ranking member of the task force, Mr.
Vargas, for 4 minutes for an opening statement.
OPENING STATMENT OF HON. JUAN VARGAS, RANKING MEMBER OF THE
TASK FORCE ON MONETARY POLICY, TREASURY MARKET RESILIENCE, AND
ECONOMIC PROSPERITY, A U.S. REPRESENTATIVE FROM CALIFORNIA
Mr. Vargas. Thank you very much, Mr. Chairman.
I want to thank the witnesses for being here today.
Mr. Chairman, you have assembled a very distinguished group
of witnesses today, and I was looking forward to discussing
quantitative easing and quantitative tightening and the
transition between scarce and ample reserves regimes and other
aspects of the Fed's balance sheet, but the developments of the
past few days have been incredibly alarming. I do not see them
as a simple distraction. The Department of Justice has
threatened Chairman Powell with a criminal indictment. The
threats represent a full-frontal assault by President Trump on
the independence of the Fed.
Just 11 days ago, after the President said, quote, ``We're
going to probably bring a lawsuit against him,'' end quote, the
Department of Justice served the Federal Reserve with grand
jury subpoenas.
This is not an isolated incident. In August, the President
said he was, quote, ``considering allowing a major lawsuit
against Powell to proceed,'' end of quote. In November, he said
of Chairman Powell, ``He should be fired, and he should be
sued,'' end of quote.
These repeated threats are designed to pressure the Federal
Reserve into submission.
Protecting the Fed's independence and credibility is
critical to a stable economy. Credibility keeps mortgage rates
low for home buyers. Credibility keeps borrowing costs
predictable for small businesses. Credibility prevents credit
card payments from spiking for working families.
When monetary policy is guided by data and evidence,
families can plan, save, and build financial security. When
Presidents attempt to interfere with the Fed, markets lose
confidence, and Americans pay the cost.
Congress imposed staggered 14-year terms to insulate
monetary policy from political pressure. Yet, President Trump
has shown he is willing to ignore that safeguard to reshape the
Fed in his own image.
Chairman Powell's professionalism, seriousness, and
character have earned him respect across ideological and party
lines. I agree with Chairman Hill when he says he knows Powell
to be, quote, a man of integrity with a strong commitment to
public service, end of quote, and Governor Cook's experience
and academic background have made her a respected voice among
economists and policymakers. Yet the Department of Justice is
threatening criminal prosecution, and next Wednesday the
Supreme Court will hear arguments on President Trump's attempt
to remove Governor Cook.
Let us be clear: This is not just about two individuals; it
is about the future of the Federal Reserve, as the chairman
noted. That is why all three living former Fed Chairs condemn
this criminal inquiry. They wrote, quote, This is how monetary
policy is made in emerging markets with weak institutions, with
highly negative consequences for inflation and the functioning
of their economies, end quote.
Congress cannot stand by and allow this to happen. That is
why I am urging the Senate Banking Committee to follow Senator
Tillis' lead and oppose the confirmation of any nominee for the
Fed until this matter is resolved. The strength of our economy
and our status as the world's reserve currency are on the line.
With that, Mr. Chairman, again, I thank you.
Chairman Lucas. The gentleman yields back.
The chair now recognizes the chairman of the full
committee, Mr. Hill, for 1 minute for an opening statement.
STATEMENT OF HON. FRENCH HILL, CHAIRMAN OF THE COMMITTEE ON
FINANCIAL SERVICES, A U.S. REPRESENTATIVE FROM ARKANSAS
Chairman Hill. Thank you, Chairman Lucas. I appreciate your
leadership and that of the ranking member.
The Federal Reserve's balance sheet is a monetary policy
tool that was once deemed unconventional some 15 years ago. Now
it is regularly used as a tool intended to keep our economy
steady and secure.
Since 2008, the Fed's balance sheet has grown
significantly. What began as a modest tool used to support
traditional monetary policy during times of stress appears to
be the central way the Fed operates. Today, we will examine
that whole process.
Quickly, before we turn to today's hearings, I do want to
emphasize what Mr. Vargas talked about. Chair Powell is a man
of integrity. This hearing today is not about these events that
unfolded over the weekend. We have a good, solid monetary
policy topic before us today, and I encourage all of our
members to ask thoughtful questions about the direction of the
Fed's balance sheet.
Regarding the hearing on the Federal Reserve's Semiannual
Monetary Policy Report, the hearing is typically scheduled at
this time of year, and the committee is at work to get it
scheduled.
Thank you, Mr. Chairman, and I yield back.
Chairman Lucas. The gentleman yields back.
Today, we welcome the testimony of Dr. Jim Clouse, senior
fellow at the Andersen Institute for Finance and Economics; Dr.
Bill Nelson, executive vice president and chief economist and
head of research at the Bank Policy Institute; Dr. Allison
Schrager, senior fellow at the Manhattan Institute; and Dr.
Bill English, the Eugene F. Williams, Jr., professor of
practice at the Yale School of Management.
Each of you--first off, thanks to each of you for taking
the time to be here. Each of you will be recognized for 5
minutes to give an oral presentation of your testimony and
without any objection, your written statements will be made a
part of the record.
Dr. Clouse, you may begin.
STATEMENT OF JAMES A. CLOUSE, PH.D., SENIOR FELLOW, ANDERSEN
INSTITUTE FOR ECONOMICS AND FINANCE
Mr. Clouse. Thank you, Mr. Chairman, Ranking Member Vargas,
and members of the task force. It is an honor to be with you
here today to discuss issues related to the Federal Reserve's
balance sheet.
My name is Jim Clouse, and I am currently a senior fellow
at the Andersen Institute for Economics and Finance. Prior to
joining Andersen, I----
Chairman Lucas. Doctor, would you pull the microphone just
a little closer to you, please?
Mr. Clouse. Is that better?
Chairman Lucas. Thank you very much.
Mr. Clouse. Sorry.
Prior to joining Andersen, I was on the Fed Reserve Board
staff for many years, with much of that time spent focusing on
issues related to the Federal Reserve's balance sheet and
monetary policy implementation.
The Federal Reserve's ``balance sheet'' is a term used to
refer to its assets and liabilities. The Federal Reserve Act
specifies the types of assets the Fed can hold. The Federal
Reserve's assets currently consist largely of U.S. Treasury
securities and agency mortgage-backed securities (MBS). On the
other side of the balance sheet, the Fed's primary liabilities
include physical currency and reserve balances held by
depository institutions. The Federal Reserve publishes a great
deal of information on the balance sheet in a range of reports.
Prior to the global financial crisis in 2008, the role of
the balance sheet in the implementation of monetary policy
centered around the use of open market operations to align
reserve supply with reserve demand at the targeted Federal
funds rate. Reserve demand was driven largely by reserve
requirements. Reserves did not earn interest, and banks sought
to keep any excess reserves to a minimum. Fed assets at this
time were almost entirely U.S. Treasury securities, with an
average maturity of about 3 years.
Over the last 20 years, the Fed's balance sheet has
undergone a major transformation, largely reflecting the policy
actions taken in response to the global financial crisis and
the pandemic. In both cases, the Federal Open Market Committee
(FOMC) reduced the target Federal funds rate to the effective
lower bound and purchased large volumes of longer-term Treasury
securities and agency securities in an effort to put downward
pressure on longer-term interest rates and ease broad financial
conditions. The expansion of the Fed's securities holdings
during these episodes was accompanied by large increases in
reserves in the banking system.
Over time, it became apparent that the demand for reserves
had dramatically changed from that prior to the Global
Financial Crisis (GFC). Surveys of banks suggested that changes
in bank liquidity regulations and a cautious approach to
liquidity risk management had contributed to higher reserve
demand.
Partly in recognition of these changes, the FOMC announced
in early 2019 that it intended to continue to operate in a so-
called ``ample reserves'' regime. The ample reserves regime has
many attractive features. First and foremost, it delivers
excellent interest-rate control, even in environments with very
large quantities of reserves in the banking system.
That said, there can be challenges in identifying whether
reserves remain ample, a point that was painfully illustrated
by a period of severe stress in money markets in September
2019. Following the period of balance sheet reduction over the
last few years, the FOMC judged that reserves had returned to
ample levels and announced that it would begin reserve
management purchases of Treasury bills to maintain ample
reserve conditions over time.
While the size of the Fed's balance sheet has now
apparently reached a new normal, the composition of the balance
sheet still has a long way to go. The FOMC has indicated that
it intends to hold primarily Treasury securities in the longer
run, but agency MBS holdings are still sizable and running off
slowly. Moreover, the maturity structure of the Fed's
securities holdings is heavily weighted toward longer-term
securities.
The FOMC'S desired long-run composition of the balance
sheet could depend on a number of policy considerations,
including potential implications for future policy actions,
Treasury market functioning, and Federal Reserve net income.
Regarding other balance-sheet-related issues, some
observers have suggested that eliminating the Fed's authority
to pay interest on reserves could be a way to boost Fed
remittances to the U.S. Treasury. Eliminating interest on
reserves would not boost Fed remittances, because the Fed's
interest income would fall along with a decline in interest
expenses.
Moreover, eliminating interest on reserves would
necessitate very large and potentially disruptive sales of the
Fed's securities holdings and would require wholesale changes
in the framework for monetary policy implementation, with the
attendant uncertainties about the Fed's ability to effectively
manage the level of short-term interest rates.
Thank you.
[The prepared statement of Mr. Clouse follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Lucas. Thank you, Dr. Clouse.
Dr. Nelson, you are now recognized for 5 minutes for your
oral remarks.
STATEMENT OF BILL NELSON, PH.D., EXECUTIVE VICE PRESIDENT,
CHIEF ECONOMIST, AND HEAD OF RESEARCH, BANK POLICY INSTITUTE
Mr. Nelson. Thank you. Chairman Lucas, Ranking Member
Vargas, and members of the task force, thank you for the
opportunity to testify.
My name is Bill Nelson, and I am chief economist and head
of research at the Bank Policy Institute. I previously served
at the Federal Reserve Board, working on monetary policy
analysis, including balance sheet policy.
The Federal Reserve's balance sheet matters because it
shapes how monetary policy is implemented, how the Fed
interacts with the financial system, and the risks ultimately
borne by taxpayers.
On the asset side, the Fed holds mainly Treasury securities
and agency mortgage-backed securities. On the liability side,
its largest item today is reserve balances--deposits of banks
with the Fed--along with currency and the Treasury's general
account.
Because currency demand is set by the public, and the
Treasury controls its own account, the minimum size of the
Fed's balance sheet is largely determined by banks' demand for
reserve balances.
Before the financial crisis, the Fed implemented policy in
what is called a ``corridor system.'' In that system, the Fed
only supplied the level of reserve balances that the banking
system needed, and private interbank markets actively
distributed liquidity and imposed discipline. The Fed had good
interest-rate control even though its footprint in markets was
tiny.
After 2008, emergency lending, quantitative easing, and the
authority to pay interest on reserves led the Fed to adopt a
``floor system,'' in which a massive quantity of reserves pins
money market rates to the floor created by the interest rate
the Fed pays for reserves.
In January 2019, the Fed formally chose to remain in that
system. That decision has had serious consequences.
First, the unsecured interbank market has withered. With an
excess supply of reserves, banks no longer need to borrow from
one another for liquidity management purposes.
Second, an unconstrained balance sheet becomes an
attractive source of funding for government initiatives. As
FOMC participants warned at the time the Fed officially adopted
a floor system, a large and unbounded balance sheet invites
political pressure to use it.
Third, the floor system may have encouraged complacency on
the part of the Fed about interest-rate risk. Quantitative
easing transfers that risk from the private sector to the Fed
and, therefore, to taxpayers. When short-term rates rose
sharply in 2022 to 2023, that risk materialized in large
Federal Reserve losses.
Fourth, abundant reserves worsen discount window stigma.
Borrowing becomes rare and signals distress, preventing banks,
supervisors, and investors from viewing the window as a normal
backstop.
Finally, there is a ratchet in the demand for reserves.
Reserve demand rises easily but falls only with difficulty
because bankers and bank examiners grow accustomed to abundant
and cheap reserve balances and make adjustments to make use of
them.
In 2008, the Fed estimated that a floor system required
about $35 billion in reserves. Today, that figure is roughly $3
trillion.
The Bank of England, the European Central Bank (ECB), the
Bank of Canada, and the Reserve Bank of Australia have
recognized these costs and are shrinking their balance sheets
and seeking to revive private markets. If the Fed wants to do
the same, it needs to take three steps.
First, move overnight market rates modestly above the
interest rate paid on reserves, creating an incentive for banks
to economize on reserve holdings.
Second, avoid repo market volatility by conducting
temporary open market operations to manage easily predictable
variations in reserve supply and demand, such as occur on
quarter ends and days with large settlements of Treasury
securities.
Third, reform liquidity regulations so that banks can count
discount window borrowing capacity established with
prepositioned collateral as a source of liquidity. This single
change would reduce reserve demand, make liquidity regulations
more accurate, encourage discount window preparedness, and
boost economic growth and employment. It would support growth
by allowing banks to make loans to households and businesses,
which they would then pledge to the Fed, rather than forcing
them to fill up their balance sheets with reserve balances.
In closing, turning a large institution is never easy, but
the experience of other central banks shows that a smaller Fed,
one that acts as a backstop rather than a market replacement,
is both feasible and desirable.
Thank you. I look forward to your questions.
[The prepared statement of Mr. Nelson follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Lucas. Thank you, Dr. Nelson.
Dr. Schrager, you are now recognized for 5 minutes for your
oral testimony.
STATEMENT OF ALLISON SCHRAGER, PH.D., SENIOR FELLOW, MANHATTAN
INSTITUTE
Ms. Schrager. Thank you for the invitation to discuss with
you today the size and composition of the Federal Reserve's
balance sheet.
I am a senior fellow at the Manhattan Institute, where I
research fiscal and monetary policy and financial markets. I am
also a columnist at Bloomberg Opinion.
The size of the Federal Reserve's balance sheet has grown
exponentially since the start of the financial crisis. This has
happened for two main reasons.
The Fed switched from a scarce reserves system to an
abundant reserves or an ample reserves system, where it sets
policy rates by paying interest on reserves. Paying interest on
reserves means banks keep more reserves at the Fed, which is
naturally going to increase the size of the balance sheet and
there are some advantages to this. It makes it easier to
control the policy rate, especially when rates are near zero.
Traditionally, the Fed bought mostly short-term Treasuries
with bank reserves, which, like reserves, are highly liquid and
have a very short duration but this changed in November 2008,
when the first of four rounds of quantitative easing commenced
and the Fed used reserves to make large-scale purchases of
longer-dated bonds and mortgage-backed securities.
The size and scope of QE is the other reason why the
balance sheet has grown as much as it has.
Now, the ample reserves system, I guess, can be justified.
It has made it easier in some ways to conduct monetary policy
within reason without causing inflation.
However, the growth of the Fed's balance sheet has not been
completely benign, because the compositions of its assets can
have a profound impact on the economy. Buying longer-term bonds
and mortgage-backed securities not only introduces distortions
into the economy, it might also threaten the Fed's independence
in the future.
Now, when the pandemic arrived and we risked a severe
recession and great disruption in financial markets, the scale
of the new QE program, QE4, was unprecedented. Cumulative
purchases since 2020 exceeded $4.6 trillion, more than all
three previous QE programs combined.
My primary concern is the risk QE introduces to the economy
with very questionable benefits. The hope is, when the Fed
reduces the supply of long-duration assets in the hands of the
private sector, long-term yields will fall, providing a
stimulative effect on the economy and when short-term rates are
near zero and we cannot go much lower. This might offer the Fed
another avenue to boost economic demand but whether the first
three rounds of QE actually had a notable and long-term impact
on interest rates is hotly debated amongst economists. One
research paper found that while Fed economists found that QE
did reduce the rate yield on 10-year bonds, academic economists
found very little or only a fleeting impact. Take that for what
you will.
So, even if there is spotty evidence of QE's impact on
long-term yields, it can still have a distortionary impact on
the wider economy.
Traditionally, bond markets are segmented. The Fed has a
significant impact on shorter-term rates--say, below 5 years--
and less impact on longer-term rates, which are set in the
market. That market price conveys very important information
about the price of risk in the economy, and it makes the
foundation of how many assets are priced throughout the
economy.
When the Fed attempts to alter this rate or simply just
becomes a large and captive buyer of longer-term bonds all
these prices then have less meaning. In that case, risk can be
mispriced, causing bubbles and financial instability. It also
poses a financial risk to taxpayers, because longer-term bonds
are more volatile, or their price is more volatile, because
they have a longer duration than the Fed's liabilities.
One estimate projects the cost of QE will be more than $760
billion.
The evidence is stronger that buying mortgage-backed
securities has a notable impact on the mortgage market by
lowering the spread between mortgage rates and bonds.
When the Fed resumed QE in March 2020, there was apparent
distress in the mortgage market, but the Fed kept buying
mortgage-backed securities for another 2 years when the housing
market had not only fully recovered but was extremely tight, as
many Americans moved homes, refinanced, and home prices hit
record highs.
We are still feeling the impact of this policy error. More
than 50 percent of mortgage holders have mortgage rates below 4
percent and cannot afford to move and take on a higher rate,
and this is constraining supply in the housing market, making
Americans less mobile and contributing to high housing costs.
Another problem with QE is, while it was relatively easy to
implement, it is very hard to end. Ending QE too quickly, as we
have seen, creates some major financial stability issues and
this creates inherent asymmetry. QE can be implemented very
quickly when the economy is weak but must be ended very slowly
when the economy is hot.
Even more worrying, if QE becomes a regular feature of
monetary policy--which it seems it has--this can pose grave
risks for Fed independence. When this is a tool in the Fed's
toolbox, it is just all too tempting to pressure the Fed to
keep the entire yield curve low in order to reduce the cost of
debt service or just lower the cost of mortgages to consumers.
Japan attempted this, at the cost of introducing major
distortions into its economy. Firms stayed in business for
years only because of the low cost of credit and this
misallocation of capital lowered economic growth and
contributed to their ``Lost Decades.''
Listen, some increase in the Fed's balance sheet is not
necessarily a concern. It can be part of a healthy and growing
economy but the reasons why the balance sheet has grown as much
as it has and the changing composition of its assets should be
a matter of grave concern for policymakers.
There may be some justification for buying assets other
than short-term Treasuries in extreme instances of illiquidity
in the spirit of fostering financial stability, but any such
program should only last a short amount of time, perhaps 6
months or less, after a liquidity event has passed and not just
be used as a way to manage economic demand or influence asset
prices.
I am happy to take your questions.
[The prepared statement of Ms. Schrager follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Lucas. Thank you, Dr. Schrager.
Dr. English, you are recognized for 5 minutes for your oral
testimony.
STATEMENT OF WILLIAM B. ENGLISH, PH.D., EUGENE F. WILLIAMS,
JR., PROFESSOR OF THE PRACTICE, YALE SCHOOL OF MANAGEMENT
Mr. English. Thank you, Chairman Lucas and Ranking Member
Vargas, for holding this hearing and inviting me to testify
today about the Federal Reserve's balance sheet.
The size and composition of the Federal Reserve's balance
sheet reflect a range of policy decisions by the Fed. For
example, lending and quantitative easing have significant
effects on the balance sheet.
One important choice affecting the balance sheet is the
method the Fed uses to implement its conventional interest-rate
policy. These policies can be implemented in a variety of ways.
One possibility, employed by the Fed prior to the financial
crisis, is to implement policy with a relatively small balance
sheet--that is, relatively low levels of securities and
relatively low levels of reserve balances at the Fed--and then
use securities purchases and sales to adjust the level of
reserves to achieve the desired outcome for short-term interest
rates. This approach is sometimes referred to as a ``scarce
reserves'' or a ``corridor'' system.
This sort of implementation was no longer possible by late
2008 because of the huge increase in reserves resulting from
the Fed's emergency lending and QE. As a consequence, the Fed
began implementing policy using the interest rate it pays on
reserves and other administered rates.
Since leaving money at the Fed is completely safe and
liquid, banks should not lend out funds at rates much below the
rate paid on reserves, and so that rate should set a rough
floor for market rates. This approach is sometimes referred to
as an ``ample reserves'' or a ``floor'' system, and it works
even with a very high level of reserve balances.
As the Fed shrank its balance sheet between 2017 and 2019,
it considered whether it should return to a scarce reserves
approach with a smaller balance sheet or stay with an ample
reserves system and a larger balance sheet. In January 2019,
the Fed announced it would stick with the ample reserves
system.
That decision reflected a balancing of a number of
potential costs and benefits. One cost, as Bill Nelson noted,
was the impact of a high level of reserves on overnight
interbank funding markets. With banks holding very high levels
of reserves at the Fed, they have little need to borrow and
lend reserves to manage their holdings, and, as a result, the
overnight interbank funding market has become much smaller and
idiosyncratic.
On the other hand, the Fed viewed the high level of bank
reserves under the ample reserves system as likely to
contribute to financial stability. In the event of a shock to
the financial system, there would be less need to add reserves,
as ample reserves would already be in place. Moreover, problems
at large banks, the failure of which could cause systemic
problems, can be managed better if those banks have a larger
cushion of reserves to draw on.
In addition, by 2019, the ample reserves system had been in
place for more than a decade, had been working well to allow
the Fed to set its policy rate, and there were presumably risks
associated with trying to transition back to a scarce reserves
regime. When policymakers assessed the overall costs and
benefits of the two systems in 2019, they concluded that
staying with the ample reserves system was preferable.
Some have expressed the concern that the Fed, by operating
with a larger balance sheet, may encourage the view that it
will use its balance sheet to address other non-monetary-policy
concerns or be willing to ease policy to address fiscal
stresses by monetizing Federal debt. However, such concerns can
arise regardless of the size of the Fed's balance sheet.
Instead, these risks point to the importance of the Fed's
monetary policy independence. The Fed should implement monetary
policy to foster the objectives given by Congress--maximum
employment and price stability--without regard for political or
other pressures to use its tools for other aims.
Thank you. I look forward to our discussion.
[The prepared statement of Mr. English follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Lucas. The gentleman yields back.
We will now turn to members' questions, and I recognize
myself for 5 minutes for questioning.
Dr. Nelson, the Fed maintains that a floor system provides
more rate control, a safer banking system, and a more resilient
Treasury market. Do you share that view and what are the
risks--what are the downside risks of a large balance sheet?
Mr. Nelson. Thank you, Mr. Chairman.
No, I do not share that view. There is, in fact, generally
widespread agreement across folks that have studied this that
both a scarce reserves system and an ample reserves system
provide good interest-rate control in normal times.
Now, it is true that when the Fed has to expand its balance
sheet in response to a crisis and reserve balances go up, what
happens at that time is: a corridor system naturally becomes a
floor system. The ECB, indeed, moved in and out of a corridor
and floor system with no difficulty during the European banking
crisis and that demonstrates that it is not necessary for the
Fed to operate a floor system all the time with the attendant
costs in order to be able to handle times of a crisis.
Moreover, it is not true that a banking system is more
resilient under a floor system. In fact, as we saw, one of the
things that a floor system does is it increases discount window
stigma, and it reduces the incentive for banks to be prepared
to use the window. As we saw in August 2023, the banking system
is much less resilient if the banks are not prepared to use the
discount window.
Chairman Lucas. Continuing with you, Dr. Nelson, banking
regulations like the liquidity coverage ratio, resolution
requirements, and liquidity stress tests incentivize financial
institutions to hold reserves, growing the Fed's balance sheet.
Should the regulators contemplate the impact that liquidity
requirements have on the size of the Fed's balance sheet and
what regulations need to be adjusted?
Mr. Nelson. Yes, they should.
Last week, we conducted a survey of our member banks and
published the results of that survey this morning on what leads
banks to demand reserve balances and what policies could change
them. The things that the banks listed were, first and
foremost, their own risk management, but then also needing to
pass liquidity requirements, as well as discount window stigma.
They indicated that the things that would most effectively
allow them to reduce their demand for reserve balances was to
recognize discount window capacity in the liquidity
requirements to which they are subject.
Chairman Lucas. Dr. Clouse, if the balance sheet gets too
large, are we not in danger of markets becoming dependent on
the Fed for proper functioning? In a crisis, Fed intervention
may be necessary, but in normal times is the Fed unnecessarily
distorting market behavior?
Mr. Clouse. Thank you.
I think that is possible and certainly was a concern at the
time when large-scale asset purchase programs were initiated,
that the growth of the balance sheet could be too rapid and
there could be problems in market functioning. In the event,
the FOMC carefully calibrated its pace of purchases and also
tried to spread its holdings of Treasury securities across a
range of quant Specialized Investment Funds (QSIFs) to address
those issues.
At present, my own sense is that the balance sheet is not
exerting any particular distortions in the Treasury market. An
interesting fact is that the Fed's Treasury holdings now, as a
share of the total Treasury market, are below those prior to
the GFC.
Chairman Lucas. Dr. English, in my view, the primary
benefit of QE is the strong signal it sends to the market that
the Fed is committed to easing policy and supporting the
economy through dramatic and unconventional actions.
Can you talk about the importance of clear communication
from the Fed as it manages its balance sheet, given that
reserve management purchases are not intended to stimulate the
economy? How can the Fed clearly communicate that to the market
and differentiate it from QE?
Mr. English. Yes. So I think----
Chairman Lucas. Hit your button, Doc.
Mr. English. Ah.
I think I agree with you that QE works in part by just
signaling resolve of the Central Bank. I think we may disagree
over other possible channels through which QE can affect
interest rates and the economy but, certainly, communication
about asset purchases is very important.
Elsewhere, I have argued that the Fed should be clear about
what the intended purpose of purchases is, and then the
purchases should be designed and calibrated to meet that
purpose. I think that is important for clarity on the part of
the Fed, for the understanding of financial markets, and so on.
In the current situation, I actually think the Fed has done
a very good job of explaining the reserve management purchases
which it started this month. It has said in its post-meeting
statement that purchases of shorter-term Treasury securities--
or, it ``will purchase shorter-term Treasury securities as
needed to maintain an ample supply of reserves on an ongoing
basis.''
So it was clear it was buying short-term Treasuries, not
long-term Treasuries, as it would for QE aimed at easing policy
and it was clear that the aim was to supply reserves and not to
provide accommodation.
Chairman Lucas. Thank you, Doctor.
My name has expired.
I now recognize the ranking member of the task force, Mr.
Vargas, for 5 minutes of questions.
Mr. Vargas. Thank you very much, Mr. Chairman. Appreciate
it.
Again, I want to thank the witnesses. In fact, I do not
want to violate any confidences here, but the chairman did lean
over to me a second ago and say that we have a really excellent
group that is testifying today.
I hope you do not mind me saying that, but I agree.
I did hear the admonishment from the chair of the full
committee that we should focus on the balance sheet today and
not talk about the issues that have happened in the last few
days, but I think, for me, that would be irresponsible, not to
talk about possible criminal prosecution of the Chairman. I
mean, I do not see how I cannot do that. I am going to.
In fact, in Chairman Powell's statement, he said this:
``This is about whether the Fed will be able to continue to set
interest rates based on evidence and economic conditions or
whether, instead, monetary policy will be directed by political
pressure or intimidation.''
Yesterday, The Wall Street Journal reported that Jeanine
Pirro, the U.S. attorney for the District of Columbia, was at a
White House event last week with other U.S. attorneys where
President Trump called them ``weak'' and said he felt
``betrayed.'' The next day, the very next day, her office sent
out grand jury subpoenas to the Federal Reserve, which I think
is outrageous.
It is interesting, too; even in all of your testimoneys
today, you all talked about the balance sheet being able to be
used for policy or political purposes, interestingly.
Dr. English, you mentioned, whether it was small or whether
it was big, that it could be used either way. It does not
matter the size; it could still be used politically.
I think that is the problem when we do not have an
independent Fed. I mean, the reason the Fed was set up in the
first place was to bring it out of the politics. That is why
they have the 14-year staggered terms.
Could you comment on that, Dr. English? Because I think
that is important for the discussion, to hear it is impossible
just simply to talk about this and not say, well, there is the
balance sheet. It is important whether we shrink it, whether we
grow it, whether it is in times of emergency, not when it could
be used politically this whole time if the President has
captured it.
Mr. English. Congressman, when Congress set up the current
structure of the Federal Open Market Committee and the Federal
Reserve Board in 1935, they were trying to ensure that the Fed
could operate independently, could operate in the public
interest.
There is a very interesting paper by Gary Richardson and
David Wilcox looking at this that came out last year.
In particular, Congress wanted to ensure the Fed was
independent of the President, who might have political and
personal incentives that would affect policy in ways that would
not be good for the public interest.
There are several pieces of the structure that help ensure
this independence. As you say, 14-year terms for Board members,
they only turn over every 2 years. That limits the number of
people that a particular President in a particular term can
nominate to the Board.
In addition, the----
Mr. Vargas. Unless he gets them removed by applying to
court, right? I mean, as he is attempting to do with Lisa Cook.
Mr. English. Let me come to that in a moment.
The votes of Reserve Bank presidents on the FOMC mean that
there are voters who are not subject to Presidential nomination
at all and that provides additional independence.
Congress intentionally put in place the arrangement that
the President could only fire Board members with cause to
protect the Fed from being used by the President to accommodate
fiscal needs.
So this was the structure that Congress intended. As you
say, we will see, in some sense, what the courts decide about
this but the intent, I think, at the time was clear, that
Congress intended an independent Federal Reserve for the public
good.
Mr. Vargas. I think it has functioned fairly well, with
exception. I mean, we did see an exception when Nixon, I think,
pushed very hard politically to change the rates.
I mean, I do not think it worked well. I mean, I do not
think it worked well in Turkiye, I do not think it worked well
in other places when the central bank is not independent from
the politics, the particular politics, of the President or
whomever the leader is of the country at that time.
Is that not correct?
Mr. English. I think that is right.
As you say, in Turkiye in recent years, there was strong
political pressure put on the central bank to leave policy easy
for too long. They ended up with very high inflation there.
I think you mentioned Richard Nixon and Arthur Burns. That
is another famous example, where Burns was an advisor and
confidant of Nixon. He wanted Nixon to be successful.
Mr. Vargas. Uh-huh.
Mr. English. Nixon put a lot of pressure on Burns to keep
policy easy. We see that in the Nixon tapes; we see that in
Burns' diary, for example. I think that did contribute--only
contributed; there were many factors at play--but it
contributed to the high inflation that we----
Mr. Vargas. My time is up. I thank you and I think it is
very dangerous what is going on right now.
Thank you. I yield back.
Chairman Lucas. The gentleman's time has expired.
The chair now recognizes the gentleman from Michigan, Mr.
Huizenga, vice chairman of the full committee.
Mr. Huizenga. Well, thank you, Mr. Chairman.
I, too, am going to divert a little bit from my prepared
questions, because I just need to point out a couple of facts.
This is my third Fed Chairman since I have come into
Congress in 2010--Ben Bernanke, Janet Yellen, and now J.
Powell.
I was chair of something called the Monetary Policy and
Trade Subcommittee, which does not even exist anymore. In fact,
I have an article from 2016 of a much thinner and slightly less
gray Bill Huizenga chairing a very similar hearing. John Taylor
was one of our witnesses, Dr. Eisenbeis, also somebody from
Cato.
So we have been dealing with this, and I will tell you, at
the time, there were friends of mine on the other side who were
very critical of Ben Bernanke and his relationship with George
W. Bush. There was a lot of us very critical of Janet Yellen
and her relationship with Barack Obama. In fact, we were
debating whether we were going to have to subpoena meeting
logs--not notes, but logs--of how often Janet Yellen was
meeting directly with President Barack Obama.
Interestingly enough, that was because people suspected
collusion between the Fed Chair and the President. Now we are
seeing sort of the opposite; we are seeing a disagreement
between the Fed Chair.
So this notion that there has never been political pressure
and that there has always been an independent Fed and it is
somehow sterile and completely independent is just a fool's
errand to pursue that.
The question that I have on this is dealing really, sort
of, with the balance sheet and reserve regime. Banks hold
plenty of reserves and do not have many incentives to trade
with each other in the Fed funds market. However, the Fed funds
market can be more susceptible to experiencing sharp changes
when conditions change.
Dallas Fed President Lorie Logan suggested that the Fed
should move away from this market; instead, target a repo rate
for monetary policy implementation.
Dr. Clouse, Dr. English, I am curious, do either of you
believe this change is something the Fed ought to consider and
what would be the benefit or challenge in doing so?
Dr. Clouse?
Mr. Clouse. Thank you. That is a very interesting proposal.
My own--and I do agree that the Federal funds market is
different now than it was in the past. I think of it as largely
a deposit market. I think it is maybe more stable than many
people think, but there are good arguments for shifting to a
broader concept of bank's marginal funding rate.
I personally am a little uncomfortable with the use of a
repo rate, because I think that ties monetary policy more
closely to Treasury financing needs, large non-bank financial
institutions.
So that is my view.
Mr. Huizenga. Real quickly, Dr. English?
Mr. English. I think I basically agree with Jim. I do not
see a need for that, and I do not think it is desirable. I
think the current system operates pretty effectively.
Mr. Huizenga. Okay.
Mr. English. So I am not sure I see a need to make a
change.
Mr. Huizenga. Dr. Schrager, why does the Fed still use
quantitative easing to stimulate an economy when the economic
community is not agreed whether the QE is actually even
effective in the first place?
Actually, that was one of my first meetings with Ben
Bernanke in my office. I am a former realtor, and I would watch
interest rates all the time. I had no other way of explaining
other than an artificial lowering of the interest rates. He
literally came out of his chair, and he was so angry. He was
like, ``We did not have a choice.''
It seems like we are in a different position now, but why
are we still using it?
Ms. Schrager. Well, certainly, when we started with QE,
interest rates were at a very--were near zero, and we were in
the midst of a very deep recession, and I think the Fed was
under a lot of pressure to feel like it was doing something and
it was something, you know?
So I think, as well, it got revised--it was supposed to
just be an extraordinary situation because this was an extreme
financial crisis, a very deep recession but I think the concern
is, one, it went on for a really long time, because it is very
hard to get out of QE, and----
Mr. Huizenga. Well, if you do not mind, I would say it is
very hard to break ourselves of the low-interest-rate sugar
high.
Ms. Schrager. Exactly.
Then, during the pandemic, it got revived even bigger.
Again--going into the pandemic, interest rates were also near
zero.
So I think, anyway, as I mentioned--and I cited a paper
that found that, while Fed economists do find it effective,
academic economists, less so.
Mr. Huizenga. I would note, one benefits professionally;
the other may not.
Ms. Schrager. Well, you know----
Mr. Huizenga. Arguably.
Ms. Schrager [continuing]. I am just citing the paper.
Mr. Huizenga. Okay.
Ms. Schrager. I think it is very tempting for the Fed to
use it just because, as I said, it needs to do something, and
it is----
Mr. Huizenga. So I referenced Dr. Taylor as having
testified. Would the Taylor rule make sense or any sort of
rule? I know the chairman is tapping, but I would love to get--
--
Chairman Lucas. The gentleman's time has expired.
Mr. Huizenga. I would love to get it in writing.
Ms. Schrager. Yes. I----
Chairman Lucas. You can respond in writing.
Ms. Schrager. Yes. I mean, I think, definitely, I am more
of a fan of a rules-based framework rather than discretion and
I think that is sort of an issue QEs. It does also leave open
more discretion.
Chairman Lucas. The chair now recognizes the gentlewoman
from California, the ranking member of the full committee, Ms.
Waters, for 5 minutes.
Ms. Waters. Thank you so very, very much.
I appreciate so very much, Mr. Vargas and Mr. Lucas, this
hearing that you have put together, and I would love to engage
with you about the balance sheet, but we should not be talking
about anything but the independence of the Fed, our central
bank.
A few days ago, President Trump again escalated his attacks
on the Federal Reserve, this time through grand jury subpoenas,
threatening criminal prosecution of the Fed's Chair, Jerome
Powell. This comes after months of Trump bringing baseless
accusations against Fed Governor Lisa Cook to remove her from
her position.
Next week, Cook's case will be before the Supreme Court,
and I expect they will reject Trump's power grab. That is
because Trump's attacks are not about transparency or
accountability; it is about his desire to control the Fed,
interest rates, and our money supply to serve his agenda and
not to fulfill the Fed's statutory mandates.
I commend Chairman Hill and others for speaking up, but
this committee, with its clear authority over the Fed, must
take a bigger role in defending the Fed's independence.
Can I just keep talking?
No, I yield back.
Chairman Lucas. The gentlelady yields back.
Ms. Waters. Oh, I am going to give him the whole 5 minutes?
[Laughter.]
Well, let me just say this. I am thinking that I am doing
the----
Chairman Lucas. Would the ranking member, yes, please
finish your 5 minutes. Of course.
Ms. Waters. Okay. We are going to get to some questions
here.
Okay. I think this first question is: It is imperative that
our committee does everything in its power to defend the Fed's
independence for the benefit of our constituents.
Chair Hill, Mr. Lucas, I would like to yield to you for a
question.
What actions will the committee take to fight back against
these efforts to undermine the Fed's independence, including
stopping this latest attack on Chair Powell from continuing?
Will you commit to holding a full committee hearing and a
bipartisan investigation? Will you issue subpoenas to the
Department of Justice (DOJ), the Federal Housing Finance Agency
(FHFA) Director Pulte, and Treasury Secretary Bessent regarding
their role in this latest attack?
Chairman Lucas. Will the gentlelady yield?
Ms. Waters. Mr. Hill is not here, and so I expect that Mr.
Lucas will answer for him.
Chairman Lucas. The task force held a hearing in September
entitled, ``Less Mandates, More Independence,'' where we
discussed Fed independence. It has been, I believe, the goal of
myself and the full committee chairman to address these issues.
I cannot speak for the full chairman of the committee, but I
much appreciate the lady's points.
Ms. Waters. Thank you very much. I take back my time.
Dr. English, time and again over the past year, President
Trump has taken extraordinary actions to attempt to control the
Federal Reserve. For example, his administration manufactured
mortgage fraud allegations to fire, again, Governor Lisa Cook
and seize more control over the Federal Reserve, and last week
his administration threatened Chair Powell with criminal
charges.
From your perspective as a former Federal Reserve official
for 25 years, how does this political interference from the
White House undermine the Fed's ability to make objective and
sound monetary policy decisions?
Mr. English. Well, I trust that it will not; that the Fed
will stand tough. I think the statement by Chair Powell over
the weekend was clear that he is not going to change his
behavior as a result of this.
So I think the Federal Reserve has legal protections to its
independence. We will see what the courts say, but I am hopeful
that the Federal Reserve will continue to use its tools to
foster its objectives set by the Congress.
Ms. Waters. Excuse me, Dr. English. Do you remember, was it
Mr. Trump that nominated and got Mr. Powell the chairmanship,
the presidency of the governing board?
Mr. English. Yes, he was the one who nominated Chair
Powell. That is correct.
Ms. Waters. Is it your experience that Chairman Powell has
been able to work effectively on both sides of the aisle?
Mr. English. Certainly that is my impression, yes. He has
talked to people on both sides of the aisle. We know that
because his calendar is public and I think he is a very smart,
talented public servant who has done a very good job.
Ms. Waters. So, basically, he has the respect of both sides
of the aisle and hopefully the courts will see this and
understand this. Is that right?
Mr. English. I would hope so, yes.
Ms. Waters. Thank you.
I yield back.
Chairman Lucas. The gentlelady yields back.
The chair now recognizes the gentleman from Wisconsin, Mr.
Fitzgerald, for 5 minutes.
Mr. Fitzgerald. Thank you, Mr. Chair.
Since the 2008 financial crisis, the Federal Reserve's
balance sheet has expanded dramatically and remains
historically large, even after a period of quantitative
tightening.
Dr. Clouse, from your perspective, how does a persistently
large Fed balance sheet affect private market intermediation,
particularly dealer balance sheet capacity? Does it risk
crowding out banks and market participants that would otherwise
provide liquidity in the Treasury market?
Mr. Clouse. Thank you for that question.
I think that was an important question, particularly on the
earlier rounds of quantitative easing, that the additional
reserves and bloating bank balance sheets could cause capital
constraint to bind more closely but we did not actually find
that to be the case. I actually think Bill English did a major
study at the time.
More recently, as I tried to indicate earlier, the Federal
Reserve's balance sheet in dollar terms is quite large, but its
holdings of Treasury securities, while large in dollar terms,
are actually quite modest relative to the size of the overall
Treasury market, on the order of, actually, prior to the
crisis.
So my assessment right now is that the Fed's holdings of
Treasuries are not having meaningful distortionary effects in
markets.
Mr. Fitzgerald. Very good. Thank you.
Dr. English argues--I do not want to put words in your
mouth, but I think this is where you are at--that the Fed's
large balance sheet and ample reserves system impose little
long-run cost, while Dr. Nelson and Dr. Schrager warn that it
distorts markets, could ratchet it upward, and expose taxpayers
to risk, ultimately.
Dr. English, what concrete metrics should Congress use to
decide when the Fed's balance sheet is too large in size
relative to GDP reserve balances, relative to bank assets,
market functioning indicators maybe, or taxpayer exposure? If
none of these work, what measurable limits should replace them,
I guess is the question?
Mr. English. Congressman, I think there are several issues
here.
One is the question of distortions. I think, as Jim just
said, if the Fed's holdings of Treasuries got very large, that
could distort the Treasury market but at the moment, holdings
are not that large relative to the Treasury market. I think it
is unlikely there are serious distortions there. You could look
at things like vast spreads and things like that in the market,
but I do not think that indicators of market functioning are
particularly showing signs of concern.
It is true that, when the Fed does QE, it purchases longer-
term securities, it takes interest-rate risk onto its balance
sheet. That is intentional. That is the way QE works. It takes
interest-rate risk out of private hands, reduces risk premiums
in private markets, lowers longer-term interest rates because
those risk premiums are lower and whether that ends up with
losses for taxpayers or not, or gains, depends on whether
interest rates after those purchases end up being higher or
lower than were expected at the time of the purchases. On
average, over time, those gains and losses you would expect to
roughly offset.
So I am not sure there are big problems here. I would worry
if the size of reserve balances got so big that it began to
impede the ability of banks to do their job but by creating the
Overnight Request for Proposal (RFP) program, the Fed provided
a safety valve where extra reserves can move out of the banking
system. What we have seen in the last year or so is, as the
Fed's balance sheet shrank, that Overnight RFP program shrank
and is now essentially gone. I think that is an indicator that
the level of reserves is now manageable for the banking system.
Mr. Nelson. Mr. Congressman, may I offer a view on the
distortions?
Mr. Fitzgerald. Yes, go ahead, sir.
Mr. Nelson. Thank you.
So one way that the Federal Reserve's large balance sheet
does distort Treasury markets is through the creation of
reserve balances, which tends to make leverage ratio
requirements more binding on the part of the banking system.
Because reserve balances are a low-risk, a zero-risk weighted
asset, when they are very high, leverage ratios tend to be more
binding.
That discourages banks and the broker-dealers owned by bank
holding companies from intermediating in Treasury markets
because that requires them to take on similar low-risk assets.
Now, the banking agencies have addressed that, to some
extent, recently by adjusting the supplementary leverage ratio
requirement but there remains the Tier 1 leverage ratio
requirement, which is binding on other banks and continues to
discourage Treasury market intermediation.
Mr. Fitzgerald. Very good. Thank you so much.
I yield back.
Chairman Lucas. The gentleman's time has expired. The
gentleman yields back.
Does the ranking member seek recognition for a unanimous
consent request?
Ms. Waters. Yes, I certainly do.
I have a unanimous consent request to enter into the record
a series of documents relating to Trump's attacks on the Fed's
independence, including: Chair Powell's statement on Sunday
about extraordinary subpoenas and criminal threats from the
administration; court documents relating to Trump's attempted
firing of Governor Lisa Cook; and statements from myself,
Chairman Hill and other Republicans, Treasury Secretary
Bessent, Wall Street executives, foreign central bankers, and
all living former Fed Chairs strongly opposing Trump's latest
attack on the Fed's independence.
Chairman Lucas. Seeing no objection, so ordered.
[The information referred to was not received prior to
printing.]
Ms. Waters. Thank you.
Chairman Lucas. The gentlelady yields back.
The chair now recognizes the gentleman from Illinois, Mr.
Casten----
Mr. Casten. Thank you, Mr. Chairman.
Chairman Lucas [continuing]. for 5 amazing minutes.
Mr. Casten. Thank you. It is always a pleasure, Mr.
Chairman.
I am going to channel my inner ``X Files'' here for a
moment. I was looking back over the history--and I love this
task force, and I think the chairman has done a wonderful job
of leading it.
We had a task force hearing just after Trump's first
tariffs announcement. We had a task force hearing just after
his attempt to fire Governor Cook and we are now having a task
force hearing just after the threats of criminal prosecution of
J. Powell.
I do not think these things are connected, but if you are
watching out there----
Chairman Lucas. I have made mistakes, obviously.
Mr. Casten [continuing]. watch when Mr. Lucas announces our
next hearing. That is probably a good time to shorten the bond
market.
More seriously, I want to be clear, I completely stand with
Secretary Powell. It is absolutely critical that the Fed be
independent from the executive. They have to be able to make
hard decisions, especially when they are politically unpopular.
I cannot believe we need to say that, but I hope that
everybody in a position of power, public or private sector,
takes the chance to make that statement, because he needs to
hear that now and our economy needs to hear that now.
Mr. Chair, in addition to the extensive list that our
ranking member just entered into the record, I would ask
unanimous consent to enter a statement from the European
Central Bank.
Chairman Lucas. The gentleman asks by unanimous consent to
enter into the record.
Seeing no objection, so ordered.
[The information referred to was not received prior to
printing.]
Mr. Casten. This is a statement from the leaders of the
Central Bank and its counterparts in the U.K., Sweden, Denmark,
Switzerland, Australia, Canada, South Korea, and Brazil,
standing, quote, ``in full solidarity'' with Chair Powell and
stating that central bank independence is a cornerstone of
price, financial, and economic stability.
I want to take a little bit of issue with what Mr. Huizenga
suggested, that this is normal. Those leaders are not compelled
to make those statements.
Mr. Huizenga. Will the gentleman yield?
Mr. Casten. No, I will not. I want to finish my comments
here.
Mr. Nelson, your organization represents the Nation's
leading banks, who manage trillions in assets. Do you agree
that Federal Reserve independence is central to the strength of
the U.S. economy and the U.S. dollar?
Mr. Nelson.
[Off-mike.]
Mr. Casten. Yes and do you agree that threats of a criminal
investigation into a sitting Federal Reserve Chair could
undermine the institution's independence, yes or no?
Mr. Nelson. I am sorry, I am not prepared to answer that
question.
Mr. Casten. Okay. Well, I just would note that Jamie Dimon,
who sits on your board, has said that those threats will likely
raise inflation expectations and raise interest rates over
time.
Do you agree with Jamie Dimon?
Mr. Nelson. I am sorry, I think it is best that I stick to
the Fed's balance sheet----
Mr. Casten. Okay.
Mr. Nelson [continuing]. which is the topic of today's
hearing.
Mr. Casten. All right.
Well, I will just read a quote from someone who is not
here.
``Thank you, Jamie Dimon, for stating reasonable facts
about the undermining of our Fed Chair Powell. Thanks for
standing up to the administration for their bullying. I salute
you, sir. Sad the politicians are scared of our leader.''
That was from the great Reggie Jackson, ``Mr. October.''
I want to move to our balance sheet, and I want to start
with how QE started.
Dr. English, there is a lot of talk about, leaving aside
Fed independence--although Fed independence certainly makes
this worse--when is the next rate cut going to come? What is
the size going to be?
How should we think--or how should the Fed think about a
lower bound so that they do not end up out of ammunition? Which
was, of course, what happened last time. Where should rate cuts
stop, if they indeed keep going forward?
Mr. English. So, if what you mean is that the Feds should
hesitate to cut rates, say, after they get to 1 percent in
order to keep their powder dry to cut later on, I think that is
a bad idea. I think, if the economy is weak, and you think
there is a real risk that you are going to end up at the zero
lower bound, if anything, you want to cut rates faster because
you want to stay away from the zero lower bound if you can
because that constraint when it binds is extremely painful. It
means you cannot provide as much accommodation as you would
like
So I would disagree with that. I think, if anything, I
would do the reverse. As I get close to the lower bound, I
would cut a little bit more.
Mr. Casten. Okay. Well, let me maybe shift, then. This is,
I guess, for Ms. Schrager. There is this tension that the Fed
will say publicly, as they should, that managing the assets on
their balance sheet should only be dealt with from a balance
sheet perspective. That is not done to affect monetary policy.
Wink, wink. Nudge, nudge. We all know it affects rates. There
has been research suggesting that the MBS purchases in 2022 had
the practical effect of making house prices go up, which of
course we are now grappling with that on the other side.
How should we be thinking about Pulte and Trump putting
pressure on Fannie and Freddie to buy mortgage-backed
securities right now? Is that not an intentional distortion of
interest rates?
Ms. Schrager. Well, I mean, Fannie and Freddy, in a sense,
are a distortion of interest rates but yes. I mean, that is, I
guess--you could argue that is serving a similar role, but I
guess the difference is, is at least it is happening in
different branch of government that is--the Fed's independence
largely exists by keeping its narrow mandate and because it is
not democratically elected in the same way other parts of the
government are. So, I mean, I am not really here to comment
about whether or not----
Mr. Casten. Is it----
Chairman Lucas. The gentleman's time has expired. The
gentleman's time has expired. The doctor can forward a written
response.
The chair now recognizes the gentleman from Louisiana, Mr.
Fields, one of my old colleagues from the 103rd Session of
Congress, for 5 minutes.
Mr. Fields. Thank you, Mr. Chairman. Let me thank all the
witnesses for being here today.
We are here today to talk about balance sheets and monetary
policy. Important stuff, no doubt, but there is an elephant in
the room that we cannot ignore. Just a few days ago, the
Department of Justice sent grand jury subpoenas to the Federal
Reserve threatening criminal prosecution of Chairman Jerome
Powell and that raises a far more pressing concern than banks'
balance sheets for the moment.
Under the guise of testimony that Chairman Powell gave to a
Senate Banking Committee last June, the President has chosen to
strong-arm the Federal Reserve by putting forward
unconscionable allegations against the longstanding
bipartisanship practice that we have had with the Federal
Reserve.
Since being elected to his second term, President Trump has
failed to recognize any form of diplomacy when dealing with
people who will not do whatever he says. Why should Chairman
Powell or anyone else, for that matter, be subject to criminal
prosecution solely for choosing not to engage in a President's
partisan politics?
Now, I have been in public service for a long time, and I
have never ever seen anything like this. Chairman Powell said
it best. ``This is not about whether the Fed will be able to
continue to set interest rates based on evidence and economic
conditions, but it is about political pressure and
intimidation.''
If a person as nonpartisan as Chairman Powell can be
subject to these accusations, is there anyone in our government
who is truly safe from similar prosecution? That is what we are
really dealing with today. So, on that, I have my first--direct
my first question to Mr. English.
Dr. English, I appreciate you being here, and I know you
have spent a good part of your career at the Federal Reserve.
In all of your years studying the Feds, in all 112 years of its
history, has the Department of Justice ever, ever threatened to
criminally prosecute a sitting Federal chair?
Mr. English. Not that I am aware of, Congressman.
Mr. Fields. Now, Dr. English, my second question to you
would be--I want you to help me explain something to the folks
back home in Louisiana. When the President goes after the
Federal--the Feds like--like this one, when he threatens the
Federal chair with prison, what does that actually mean for
families in Baton Rouge trying to buy their first home? What
does it mean to a senior citizen in Shreveport living on a
fixed income? Break it down for me. What happens to regular
people when you shake the confidence in the Federal Reserve?
Mr. English. So, I think the risk, Congressman, is that, if
the President were successful in undermining the Fed's
independence, then monetary policy would be made in the
interest of short-term political gain and not in the interests
of the objectives set by the U.S. Congress, maximum employment
and stable prices. The likely effect is that monetary policy
will be too easy. Presidents often call for monetary policy to
be easier. They rarely call for monetary policy to be tighter
and so the result would be higher inflation over time. There is
a lot of empirical evidence that less independent central banks
deliver higher average inflation over time, also more volatile
inflation over time, I think.
So granting central banks independence brings inflation--
helps keep inflation low and relatively stable so everyday
Americans, as they look at this issue about central bank
independence, they should be concerned that, if independence is
undermined, the effect will be higher inflation, higher cost of
living, and more uncertainty, more volatility around the cost
of living over time.
Mr. Fields. My last question to you, Mr. Nelson. Your
member banks need stable monetary policy to do business. They
need predictability. So, with that said, what is your feeling
about the attacks on the Feds?
Chairman Lucas. The witness will need to respond to that in
writing. The gentleman's time has expired.
Mr. Fields. I thank the chair, and I yield back the
balance----
Chairman Lucas. Thank you.
The chair now recognizes the gentleman from Nebraska, Mr.
Flood, who is chair of the Subcommittee on Housing, for 5
minutes.
Mr. Flood. Thank you, Mr. Chairman.
The subject of today's hearing is exceptionally important.
The Federal Reserve's balance sheet grew exponentially after
the recession of 2008 and then grew again after the coronavirus
disease 2019 (COVID-19) pandemic. This is part of a trend in
Federal Reserve monetary policy over the last 20 years. In
harsh economic times, the Federal Reserve purchases assets,
whether it be treasuries, mortgage-backed securities, or other
assets. Then, in fairly stable economic times, the Reserve lets
those assets roll off the balance sheets slowly as they mature.
We have seen this escalation play out once. Back before the
financial crisis in 2008, the Federal Reserve's balance sheet
was only around $900 million. However, before the Federal
Reserve began purchasing assets in 2020 to combat economic
instability from the COVID-19 shutdowns, the balance sheet was
already around $4 trillion. Today, the Federal Reserve's
balance sheet is at 6.5 trillion, which is still higher than
where the balance sheet was prior to 2020.
If the Federal Reserve already has a $6 trillion balance
sheet when the next recession hits, the Federal Reserve will be
more--will be--being more assets on top of their already
elevated holdings. My concern is whether this is sustainable
long term.
If quantitative easing remains a tool in the Federal
Reserve's toolbox in the event of economic turbulence, would
not a larger balance sheet in good times blunt the economic
impact of that tool when things get tough?
My first question: Dr. Clouse, Dr. Nelson, Dr. Schrager,
would you mind reacting to that sentiment? How should we be
thinking about the implications of a larger Federal Reserve
balance sheet for future bouts of quantitative easing?
Mr. Clouse. Thank you. I will offer my comments.
As you indicated, Federal Reserve has embarked on those QE
programs in response to very severe adverse shocks. I would not
anticipate balance sheet expansion beyond just what was
necessary to accommodate the trend in growth and currency and
other technical factors in normal times. It is true that the
dollar of magnitude of the Fed's current balance sheet is
sizable, but it has--Federal Reserve through the last few years
has reduced the size of the balance sheet relative to non-GDP
quite substantially, so.
Mr. Flood. Mr. Nelson. Dr. Nelson.
Mr. Nelson. Thank you.
I think the big challenge--the particular challenge is that
once--every time the Fed increases its size, that size gets
locked in, and it has to increase it further. For example, as I
noted in 2008, the staff judge that--30 billion was needed to
conduct policy over the floor system. Now it is 3 trillion.
But, importantly, when the Fed decided to adopt a floor
system, the staff estimated that it would require 1 trillion in
reserves. At that time, in large part because Chair Powell
wanted to be able to demonstrate that QE could be reversed, he
indicated that while 1 trillion--I will support it at that
level, but if it turns out to be 1.5 trillion, then I will have
buyer's remorse.
Eleven months later, the staff revised its estimate of the
amount needed to 1.5 trillion. So I think that the fundamental
tendency for the balance sheet to just have to keep growing is
part of the severe problem with the approach.
Mr. Flood. Dr. Schrager?
Ms. Schrager. Yes. I agree with all of that. I think what
we are seeing as well is financial markets become very
dependent on this. I mean, that is one of the reasons why they
have even had to end quantitative tightening already is sort of
maintaining their ability to do the ample reserve system is
sort of--really limits the size to even shrink the balance
sheet and this is one of the reasons why it just seems to be
growing and growing and growing.
Mr. Flood. The minutes of the Federal Open Market Committee
meeting in December suggested that they would stop quantitative
tightening, which would have continued to shrink the size of
the Federal Reserve's budget over time. Dr. Clouse, Dr. Nelson,
and Dr. Schrager, with the Federal Reserve's balance sheet
still at 6.5 trillion and the end of quantitative tightening,
how large can we expect the balance sheet to get after the next
round of quantitative easing? This is kind of a speed round
because I have 50 seconds. Dr. Clouse.
Mr. Clouse. It is hard to say because the quantitative
easing episodes are really largely restricted to severe adverse
economic shocks. So it would depend on how adverse those shocks
are.
Mr. Flood. Dr. Nelson?
Mr. Nelson. The Federal Reserve cannot get any smaller than
the sum of banks' demand for reserves and the Treasury's
general account and the currency. Those things are going to be
growing over time, which is why the Fed is currently purchasing
securities in order to hold the level of reserve balance as
relatively constant. So it is going to grow over time. As Jim
noted, really, the amount of quantitative easing that might be
necessary if, again, they reached zero would depend upon the
circumstances.
Mr. Flood. Dr. Schrager.
Ms. Schrager. Yes. Again, it would depend on the nature of
the shock and where the shock was, if it was in the mortgage
market or even maybe corporate bond market or what have you,
but I think, as we are seeing, it is going to be bigger each
time.
Mr. Flood. Thank you very much for your testimony, and I
yield back----
Chairman Lucas. The gentleman's time expired.
The chair now recognizes the ranking member for a unanimous
consent request.
Ms. Waters. Thank you very much.
I have a unanimous consent to request to enter into the
record a set of documents relating to the Trump
Administration's radical theory about the Federal Reserve
lacking authority to transfer Consumer Financial Protection
Bureau (CFPB) funds that was rebutted--that was rebutted by
former Fed officials, including one of our witnesses, by
Democratic committee members and by a Federal judge.
Chairman Lucas. Seeing no objection, so ordered.
[The information referred to was not received prior to
printing.]
Chairman Lucas. The chair now recognizes the gentlewoman
from Oregon, Ms. Bynum, for 5 minutes.
Ms. Bynum. Good afternoon, Chair Lucas and Ranking Member
Vargas. Thank you for holding this important meeting today on
balance sheets and I would like to thank our witnesses for
being here today to discuss this very important issue.
I will say I cannot sit here and pretend that this is
business as usual because it is not. The Fed, which our
committee oversees, I believe is under attack by the Trump
Administration and the American people cannot afford for us to
sit around talking about our balance sheets and pretend that
this is not happening. When I am home in my district, people
ask me what do I believe and I tell them ``Believe what you see
right in front of your very eyes,'' and this is what I am
seeing.
This attack on the Fed threatens to raise costs, hurt
retirement accounts, and mess with our entire financial system.
As you know, the Fed is mandated to be independent of the
President, and that independence has meant over the last year
that the Fed has done what is best, I believe, for the American
people, not catering to President Trump. Now the Trump
Administration is threatening criminal investigations into
Jerome Powell, the Fed's Chair, and attempting to use the Fed
to play political games.
Now, I would argue that this is not some partisan attack on
Trump by Democrats. Global central bank chiefs and top Wall
Street bank CEOs are supporting Chair Powell. Senior Republican
Senators on the Senate Banking Committee have come out against
the investigation. Even Chairman Hill, the chair of this
committee, said it, quote, creates an unnecessary distraction.
I am a moderate Democrat, so I believe my Republican colleagues
from time to time. This is unusual but it is necessary for us
to tell the truth about what is happening.
Let me tell you what happens if the President can bully or
threaten the Fed Chair: Interest rates become a political tool.
Inflation becomes a campaign strategy and your mortgage, and
your job and your savings become collateral damage.
So let us be clear here: This is not the first time the
President has done some foolishness that hurts our economy. In
his first term, unemployment has risen to the highest rate
since the Great Depression. Since he has taken office this
time, businesses have had to pay over $1 trillion in tariff
costs. That affects my State and the people of Oregon.
Today, everyday items are still too expensive, and
President Trump needs to stop playing games with our economy
and our wallets and focus on making things cheaper. Attacking
the Fed does not do that. So make no mistake. This attempt to
intimidate the Fed is not about justice or the American people.
According to my staff, it is about the President's ego. You
could argue about that, but I cannot and I will not stand by
and let that happen. I will continue fighting to make sure that
the Fed works for Oregonians and not our President,
particularly.
Thank you, and I yield back.
Chairman Lucas. The gentlelady yields back.
The chair now recognizes the gentleman from Texas, Mr.
Green, for 5 minutes.
Mr. Green. Thank you, Mr. Chairman. I thank the ranking
member as well. I concur with something the ranking member said
at the genesis of his statement, or perhaps it was at the
closing. Maybe it was at Revelations.
He talked about the dollar as the reserve currency. It is
the reserve currency of choice globally. As such, it affords us
such--some preeminent privileges that many other countries do
not enjoy. I would like for you to indicate to me whether you
think that losing its independence would have some impact on
the dollar as a reserve currency of choice. Mr. English, would
you kindly start? We will move from your left down the line.
Mr. English. Yes. Congressman, I think that is correct. If
the Fed we are seeing is not independent and that would lead to
real concerns about high inflation. I think longer term
interest rates would probably rise, and people would pull back
some from holding dollar assets. So it would hurt the dollar's
role as the world's reserve currency. The extent of that would
depend some on how bad people thought monetary policy was going
to be with less Fed independence.
I think there also is a problem because there is not a good
alternative reserve currency. There is not another market that
is as big and as liquid as the Treasury market. So I do not
know how far that would go, but at the margin, it would surely
reduce the use of the dollar as the reserve currency, yes.
Mr. Green. Thank you. Let me continue with Mr. English for
just a moment more.
Mr. English, there is a war for currency supremacy. You
caused me to come into this line of thinking with your
commentary and there are other countries that would dearly
enjoy having the prominence that our country has with its
currency. The dollar is used in many ways. When we sanction
countries, we can deal with them by way of manipulating the
dollar--our currency.
Does that concern you, our ability to impose sanctions,
because we have allowed somehow our supremacy with the dollar
to erode?
Mr. English. I think it would depend a great deal on what
the alternative reserve currency was that emerged. I think if
it were Euro-denominated securities, if there were EU bonds
that were issued, for example, I am not sure it would actually
make a huge difference. If there was a big shift to the
renminbi, for example, then of course there would be.
On the other hand, I think--I think the renminbi is a long
way from being a global reserve currency because there is not
capital market openness in China, and so there are real limits
to how much people want to hold their reserves in the Chinese
currency.
Mr. Green. Thank you for this.
Next point. As a magistrate, I conducted many probable
cause hearings, practiced law for a good many years and it is a
very basic fundamental principle that you do not investigate
without some cause. You just do not decide one morning that you
are going to investigate the chair of the Fed to do so without
some cause. Where is the cause? Where is the transparency that
would lead the American people and, in fact, the world to
believe that this is a legitimate investigation as opposed to a
vindictive means by which a President can acquire control of
the Fed? Where is the probable cause? By the way, this is
rhetorical. I do not expect any of you to answer this. Okay. Do
not--please do not.
This is, without question, creating an erosion in the
confidence that we will have in the Fed, saving one thing:
President Powell. He has stood his ground. He is not a man who
is going to allow the President to just walk over him.
Mr. Powell, Mr. Chairman, if you hear this message, I thank
you for what you are doing to stand your ground. Continue to
have courage to take on this reckless, ruthless President who
ought to be impeached.
I yield back.
Chairman Lucas. The gentleman's time has expired. The chair
now recognizes the gentleman from Montana, Mr. Downing, for 5
minutes.
Mr. Downing. Thank you, Chairman Lucas.
Since the 2008 financial collapse, we have seen the Fed's
balance sheet increase substantially, as we have talked about
here today. I really appreciate the discussion we have had to
evaluate the effectiveness of the Fed's balance sheet targets
in promoting economic stability.
I am going to start my questioning with Dr. English. What
would it look like if we--if the Fed shrank its balance sheet
to pre-2008 levels, both the dollar amount or as a percentage
of GDP and would that be a wise decision?
Mr. English. So I think we do not know exactly what that
would look like. I think one of the reasons why the Fed has
been hesitant to move to a smaller balance sheet is they do not
know how that would play out. We do not really know what the
demand for reserves would look like in a system like the one
that we had before the financial crisis and we do not know what
stumbles there would be along the way back to that, that
smaller balance sheet.
So I think it is just very hard to say. The point I would
emphasize--and here I am going to disagree with Bill Nelson,
for sure, so you should ask him these questions too, but I
think it does not matter as much as you perhaps would think.
The Fed can implement policy with a bigger balance sheet or a
smaller balance sheet. What is important is that it can
successfully implement policy and it can. I used to travel
around a lot and talk to central bankers from other countries.
They all implemented policy in different ways. They all thought
their way was the right and obvious way and everybody else was
crazy. I think the way that you implement policy is less
important than it simply being an effective way to implement--
--
Mr. Downing. Thank you. I appreciate that.
Mr. Clouse, do you believe that would be a wise decision?
Mr. Clouse. No. I do not believe it would be a wise
decision, partly for the reason Bill just described. We do not
really know what reserve demand looks like. Also, I think the
world is quite different now than it was in 2007. Notably, the
Federal debt outstanding is much, much larger than it was then,
and there are linkages now between repo markets and overnight
funding markets and money markets now that are just much larger
than they were in the past. We do not really understand those
as well as we would need to in order to be able to make that--
that sort of move.
Mr. Downing. So we are not clear on the effects it would
have if we brought the balance sheet grow too quickly or too
much, what affect that would have on the market?
Mr. Clouse. That is my--that is my view. I mean, we all
like to have nice smooth reserve demand curves, but the truth
is we do not really have a good sound understanding of what
those----
Mr. Downing. Thank you.
There has been a lot of discussion this Congress about
maintaining the independence of the Fed, which I strongly
support. This question is for Dr. Schrager and for Dr. Nelson.
Is it easier for the Fed to lose its independence if its
balance sheet is too large? If so, are there policy
recommendations that you have for Congress to consider? Start
with Dr. Schrager.
Ms. Schrager. Yes. I mean, it depends on what you mean by
``too large.'' As I said, it is not only the size of the
balance sheet, it is also its composition and as it is buying
assets other than short-term treasuries certainly long data
treasuries or mortgage-backed securities or briefly corporate
bonds, which other countries have gotten into, or even stocks,
then you really do have a serious threat to Fed independence
because it becomes all too easy for the President to say, ``I
want lower mortgage rates, buy more mortgage-backed
securities,'' or, as we have seen in Latin America often, the
cost of servicing the debt is way too high; we want the Fed to
lower rates. I mean, large debt is traditionally the biggest
threat to Fed independence, and that is certainly a risk we
have been playing with for a long time.
Mr. Downing. Thank you. Dr. Nelson.
Mr. Nelson. I do think that it puts risk to the Fed's
independence. Back--the way the Fed used to conduct policy,
reserve balances were extremely low so the Fed could get no
bigger than the public's demand for currency and the Treasury's
general account but if the Fed tried to get bigger, it would
lose control of monetary policy under the old regime. Under the
current regime, the Fed's balance sheet is effectively
unbounded, and that makes it a more attractive target, as
several FOMC participants have indicated, for political
manipulation. We have seen that with the Coronavirus Aid,
Relief, and Economic Security (CARES) Act, which--in which
directed the Fed to fund--to extend credit to middle market
firms rather than Congress doing so itself, and the Fed did. We
see it--we saw it with the Federal Deposit Insurance
Corporation (FDIC) borrowing from the Fed rather than the
Treasury, which was bound by the debt limit at that time to
fund its bailouts of uninsured depositors in the spring of
2023.
Mr. Downing. Thank you. In my last second--actually, Mr.
Chair, I do not have time for next questions. I will yield
back.
Chairman Lucas. The gentleman yields back.
The chair now recognizes the gentleman from Illinois, Mr.
Foster, who is ranking member of the Financial Institutions
Subcommittee, for 5 minutes.
Mr. Foster. Thank you, Mr. Chair, and to our witnesses.
I take it all of you have probably had a chance to read the
statement on the Federal Reserve independence from all of the
luminaries: Ben Bernanke, Bernstein, Jason Furman, Tim
Geithner, Phil Gramm, Alan Greenspan, Glenn Hubbard, Jacob Lew,
Greg Mankiw, Hank Paulson, Ken Rogoff, Christina Romer, Robert
Rubin, and Janet Yellen. You have all had a chance to read
that, I presume. So my question to you is--if you had been
asked to sign, were in the position there--if you had been
asked to put your name on that, would you have put your name on
that statement, and why or why not? Just start from the right.
Dr. English.
Mr. English. Yes, I would have.
Mr. Foster. Dr. Schrager.
Ms. Schrager. I mean, I do not like to sign statements, but
I am supportive of the spirit. Yes.
Mr. Nelson. I am sorry. I have not read the statement, but
I do think Fed independence is a national asset, a precondition
for low inflation and prosperity. I think the Fed is subject to
congressional oversight, and this task force is an outstanding
example of that oversight.
Mr. Clouse. I have not read those particular statements
either, but I am certainly a strong supporter of Fed
independence. Thank you.
Mr. Foster. Well, I urge you to take a--well, to read it. I
mean, it was a very eloquent thing. There was a similar
statement from international central bankers from everywhere
from Korea to Canada to the Bank of England and they understand
what is at stake, and they see--they look on in sympathy. When
you see third-world countries find their central bank come
under assault, and you see the damage that does to the citizens
of those countries. We do not want to go down that road.
So let us see. There are a number of things. One of the
things that has come up here, the Taylor Rule. Up there on the
wall is--for many, many years, we sat there and had endless
debates about whether you could replace the entire Federal
Reserve with a Taylor Rule, which is a little formula that has,
I think, one or two free coefficients in it. For example, one
of its many shortcomings--it does not have anywhere in it the
balance sheet of the Federal Reserve, which is obviously a big
player in this. So Albert Einstein has a famous quote that
theories of the world--of the universe should be as simple as
possible but no simpler. It always struck me that the monomania
by the former chair about ``let us just get rid of the Federal
Reserve and follow the Taylor Rule,'' it just seems like that
cannot possibly work. It is sort of mind-numbing to me to find
that from going to having no freedom at all from Federal
Reserve be the position of the Republican Party, and now we
have, ``Oh, everything the Federal Reserve does should be at
the whim of one man,'' is now the current position. I just find
that hard to actually understand.
Do you--there is--I find myself in the middle--from time to
time will go and download one of these macro models and make a
few experiments. I am very pleased that people have
transitioned away from MATLAB to Python in those. So there is a
lot to learn, but there has also got to be a human part of that
too. It is not just the models. I was just wondering what--you
know, why--why we have been so proud for so long, and now we
seem to have gone off course on this? Did any of you have
comments on that or--yes.
Mr. English. I am sorry. I missed the last sentence----
Mr. Foster. Well, just the--you know, why--you know, what
is it that is really at stake here? When you say that, instead
of having thoughtful debate, partly quantitative and partly gut
feeling for where markets are moving and--which is, I think,
the only way that you will have a workable monetary policy.
Now, all of a sudden, we are sitting there just talking about
whether just some guy trying to run a gang should order
people--you are all familiar with countries where that has
happened and why is it we have not decided to fight for that as
a country?
Mr. English. So, if you are asking whether I think monetary
policy should be done in a deliberative way based on data and
judgments and assessment, sure.
Mr. Foster. Partly. Partly and then there is a--there is a
gut feeling part of it too.
Mr. English. I am sorry?
Mr. Foster. There is a gut feeling part of it too. You run
all the models you can. You average all the models in your
brain and then in the end you----
Mr. English. There is an element of judgment to all of
these things.
Mr. Foster. Yes. So that seems to be the only way it will
work. I--just wondering now when you find that all of that hard
work by brilliant people is just being run roughshod over, it
is just--it is amazing that every--every credentialed economist
in the country is not standing up and yelling at least as
clearly as those ladies and gentlemen on that list I just read
off.
Anyway, I just want to--you have important voices. You are
up in front of an important committee of Congress and it
matters that we all stand up in this together.
Chairman Lucas. The gentleman's time has expired.
Seeing no other requests for time, the chair would like to
thank all the witnesses for your written and oral testimony
today. Your input is invaluable as we as a task force try to
address these questions of independence and the Fed balance
sheet.
Without objection, all members have 5 legislative days to
submit additional written questions for the witnesses to the
chair. The questions will be forwarded to the witnesses for
their response, and witnesses, please respond no later than
February 18, 2026.
[The information referred to can be found in the appendix.]
This hearing is adjourned.
[Whereupon, at 3:47 p.m., the committee was adjourned.]
APPENDIX
----------
MATERIALS SUBMITTED FOR THE RECORD
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
[all]