Money, Banking, and Financial Markets

The Fed's Reserve Management Revisited

The Federal Reserve faces a delicate dilemma: shrinking its balance sheet without sparking interest‑rate volatility. Recent research by Darrell Duffie and Fed officials highlights that today’s payment system, especially Fedwire, is the primary driver of banks’ structural reserve demand. Policymakers are weighing tools that lower reserve demand—such as payment‑netting, relaxed overdraft rules, and broader collateral eligibility—against the risks of shifting liquidity burdens back to the central bank. While temporary open‑market operations can smooth predictable shocks, more ambitious reforms like tiered reserve remuneration encounter political resistance.