The Fed could shrink its balance sheet by two trillion, but nobody dares touch this constraint
The Fed's balance sheet is over six trillion, of which three trillion is reserves. Miran's menu says that by pushing down reserve demand you can shrink one to two trillion without disturbing short-end markets — provided you admit that regulation is the real constraint.
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The argument · tap a timestamp to hear it
Regulatory dominance is the real constraint on shrinking the balance sheet
Miran places "regulatory dominance" alongside fiscal dominance and monetary dominance: the reason banks hold reserves far in excess of their liquidity needs is not that the market requires it, but that regulation requires it plus the stigma attached to drawing on the discount window. The mechanism he gives: banks fear being drained at the moment they truly need liquidity, so they hold a precautionary buffer; at the same time, requirements like the LCR and internal liquidity stress tests turn reserves into a de facto floor. So the first step in shrinking the balance sheet is not reducing supply but pushing down demand — demand shifts left, and only then can supply shift left with it without changing the price.
— Stephen MiranShrinking one to two trillion does not require leaving the ample reserves framework
Miran and his coauthors' estimate: within the ample reserves framework, by lowering reserve demand you can shrink one to two trillion dollars of reserves. The balance sheet is currently about 6.7 trillion, roughly 20% of GDP; after shrinking that portion it would be back to around 15%. If you were willing to leave the ample reserves framework and return to scarce reserves, the room to shrink would be far more than two trillion — before the crisis only about 50 billion in reserves supported an 8 trillion balance sheet, because banks could then borrow intraday overdrafts without stigma. But the cost is volatility in short-end funding markets, and that is a trade-off the Fed has to make for itself.
— Stephen MiranYou cannot go back to the pre-crisis world, because interest on reserves and Basel cannot be dismantled
Miran agrees with the host's judgment: even returning to scarce reserves, you could not abolish interest on reserves. Before the crisis, interest on reserves was effectively zero, amounting to a heavy tax on banks for holding reserves, so banks desperately avoided them. Now banks pay depositors a rate significantly below the interest rate on reserves, so holding reserves is itself a sizable spread business. The other thing that cannot be dismantled is the Basel system and Dodd-Frank: Congress legislated the implementation of these regulations that push up reserve demand, and the LCR can be narrowed, can be relaxed, but cannot be repealed. So the direction can be traveled, but the clock cannot be fully turned back.
— Stephen MiranExpanding FEMA access is adding a liquidity premium to Treasuries
Miran supports expanding FEMA access. The mechanism: buying long-duration Treasuries is equivalent to locking up your money, and when you need short-end liquidity, selling means crossing the bid-ask spread and bearing price volatility. If quasi-sovereign institutions like sovereign wealth funds could also pledge long-duration Treasuries to FEMA in exchange for short-term cash, the appeal of long-duration Treasuries rises, the relative appeal of reserves falls, and at the same time the appeal of the entire Treasury asset class rises, bringing capital inflows into the dollar system and strengthening dollar dominance. But he stresses the need for haircuts to protect taxpayers — for counterparties like the Bank of Japan and the European Central Bank none is needed; expanding to other counterparties requires a tiered design.
— Stephen MiranDiscount window stigma is an inefficient implementation of the regulatory system
Facing the challenge of why free-marketeers want banks to use the discount window more, Miran's response is: the alternative is not doing nothing, but maintaining a larger and more distorted balance sheet. America has already decided that bank failures are too costly and that regulation is needed to avoid a deflationary depression, so the question becomes how to implement that regulation most efficiently. Banks need liquidity partly precisely to satisfy reserve and HQLA regulatory requirements. He uses two analogies: never missing a flight means you are wasting too much time at the airport, and the optimal number of missed flights is not zero; likewise, the optimal number of bank failures is not zero, but it should be a low positive number.
— Stephen MiranBanks are digging for change in the sofa because there is nowhere to put their assets
Responding to Waller's analogy about why make banks dig through the sofa cushions for change, Miran turns it around: if banks really are digging through the sofa cushions, that means they have not piled the cash on top of the sofa — that is, they have not effectively deployed their assets into the real economy. This is not the banks' problem; it is over-regulation preventing banks from lending, so small businesses, households and firms cannot get bank credit, and private credit and private lending have therefore exploded. Miran says he is not opposed to private credit, but he does not want lending decisions made to arbitrage the regulatory system rather than on economic fundamentals.
— Stephen MiranSimple-sum M2 conflates transactions and savings
The paper Miran coauthored with Nuriel Roubini and Peter Ireland argues for reviving monetarism, with Divisia monetary aggregation as the core tool. The logic: M2 adds money market funds and demand deposits with the same weight, but the former is mainly used for saving and the latter mainly for transactions. Financial innovation (such as the introduction of money market funds) distorts simple-sum measures. Divisia weights by "moneyness," just as housing carries more weight than video games in the CPI. After weighting, Divisia velocity is more stable than simple-sum velocity, because financial innovation is absorbed by the weights.
— Stephen MiranReread both crises through Divisia and monetarism was right both times
Miran offers two tests: in the post-GFC period, simple-sum M2 exploded because of QE, and countless commentators predicted hyperinflation, yet what followed was persistent deflationary pressure; the Divisia measure captured the strong deflationary pressure from the shadow banking system and would have told you policy was not loose enough. In the post-pandemic period, the Divisia measure showed a great deal of latent inflationary pressure, and then correctly captured the disinflation from 2022 to 2025. He states explicitly that this is not about replacing everything with monetarism, but about having another tool in the toolbox, a cross-check. He also stresses: right now these data do not say the Fed is behind the curve — 2021 was when it was.
— Stephen MiranIn their own words · checked verbatim
it's like antibiotics, you know, you use them when you're sick, you don't use them when you're not.
Stephen Miran21:19
If demand goes left, you can shift supply left too without changing prices. Right? Simple econ 101.
Stephen Miran25:24
I have a personality problem which is that whenever somebody tells me you can't do something I have to I have to find out if it's true.
Stephen Miran30:25
if you never miss a flight, you you're wasting too much time at the airport.
Stephen Miran39:31
I don't want people making borrowing and lending decisions to maximize uh arbing the regulatory system I want them doing it for the economic fundamentals
Stephen Miran43:33
Figures
| Fed balance sheet size | About 6.7 trillion dollars, roughly 20% of GDP | 23:20 |
| Fed reserves | Slightly above 3 trillion dollars | 24:22 |
| Reserves that could be shrunk within the ample reserves framework | 1 to 2 trillion dollars | 25:24 |
| Pre-crisis reserves | About 50 billion dollars, supporting an 800 billion dollar balance sheet | 26:25 |
| Fed deferred assets | More than 1 trillion dollars | 18:17 |
| Pandemic-era year-over-year home price gain | 20% | 17:17 |
Glossary
- regulatory dominance
- Regulatory requirements themselves becoming the dominant force determining reserve demand and balance sheet size, alongside fiscal dominance and monetary dominance.
- Divisia monetary aggregates
- A monetary measure that weights each type of money by its "moneyness" rather than simply adding them up, named after the French economist Divisia.
- FEMA
- The Fed's Treasury repo financing facility for foreign central banks and similar institutions; expanding access can raise the appeal of long-duration Treasuries.
- HQLA
- High-quality liquid assets that regulation requires banks to hold; reserves are the easiest of these to manage day to day.
- LCR
- A regulatory ratio requiring banks to hold enough high-quality liquid assets to cover short-term net outflows, which pushes up reserve demand.
- ample reserves
- The Fed's current operating framework, in which reserve supply is far above demand and short-end rates are controlled by administered rates.
How to listen
Macro investors and researchers tracking the Fed's operating framework, the path of balance-sheet shrinkage, and monetary policy; anyone who wants to understand how regulation determines reserve demand and why monetarism may be coming back.
The opening chit-chat about the division of labor between CEA and NEC and the layout of the Fed building — skip to the balance-sheet-shrinkage section at 9:10.