Since the financial crisis broke in 2007, the Fed has struggled to keep the economy intact with a series of novel strategies including the massive purchasing of Treasuries and mortgage backed securities, known as quantitative easing.
As a result, its balance sheet has swelled to more than $3 trillion from less than $900 billion--a bloat that is worrying many in the financial markets. How can the Fed reduce its balance sheet—its exit strategy—without overwhelming the markets with so much money that inflation sets in, rising at a rate that the Fed can’t control?
Jeremy Siegel, the renowned finance professor at the Wharton School of the University of Pennsylvania and author of “Stocks for the Long Run,” has a proposal to help the Fed.
Related: There are No Bubbles, QE is Working
In a recent Financial Times Op-Ed, Siegel proposes that the Fed raise bank reserve requirements to around 15%. That would absorb almost all the banks’ excess reserves of about $1.7 trillion so that when the economy picks up the banks won’t flood the market with money. He calls it a “win-win” strategy that would “mop up all the excess liquidity."
Siegel tells The Daily Ticker: “It could be very inflationary if our economy revs up to have all those excess reserves turned into money, into deposits, into loans. One way to prevent them [the banks]f rom doing that is to say you can’t use those excess reserves to make extra loans.”
The Fed in turn wouldn’t be under as much pressure to reduce its $3 trillion balance sheet, selling Treasuries and mortgage-backed securities into a market with already rising rates.
Siegel says he doesn’t know if the Fed is discussing his idea but he says it’s a tool that the central banks shouldn’t ignore. He says it’s been available for about 100 years but hasn’t been used for the last 30. Siegel told The Daily Ticker even raising reserve requirements to 8 or 10% would be helpful.
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