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Beth Hammack, president of the Federal Reserve Bank of Cleveland, is saying the quiet part out loud: the Fed doesn’t fully understand what its massive balance sheet is doing to the economy. In remarks to the Money Marketeers of New York University, Hammack acknowledged that identifying when reserves transition from abundant to scarce is “extremely difficult,” a candid admission from someone sitting inside the institution responsible for managing those reserves.
The comment lands at a moment when the Fed’s balance sheet stands at roughly $6.7 trillion, down from a peak near $9 trillion in early 2022. That’s a substantial reduction, but still enormous by any historical standard. And Hammack is essentially arguing that nobody has a clean model for what all that balance sheet heft actually means for markets, borrowing costs, and risk-taking behavior.
The case for shrinking, slowly
Hammack isn’t calling for the Fed to slam on the brakes. Instead, she’s advocating for a measured pace of quantitative tightening, the process by which the Fed lets bonds roll off its balance sheet without reinvesting the proceeds. The goal is to land in what she describes as a “just-above-ample” reserves regime.
That second risk isn’t hypothetical. In September 2019, overnight repo rates spiked violently when reserves drained below the comfort zone, forcing the Fed into emergency interventions. The episode remains a cautionary tale for policymakers trying to calibrate the drawdown.
Hammack laid out specific costs of keeping the balance sheet unnecessarily large. The Fed pays interest on the reserves that banks park with it. A bigger balance sheet means more reserves, which means larger interest payments. Those payments come out of the Fed’s remittances to the US Treasury, which is another way of saying the public foots the bill. She also flagged a subtler concern: an oversized balance sheet can dampen market volatility, which sounds nice until you realize it encourages the kind of risk-taking that tends to end badly.
Why the low-rate era might have been the anomaly
One of Hammack’s more provocative observations is that the prolonged period of ultra-low interest rates may have been unusual rather than a new normal. This matters because much of the modeling around balance sheet effects was built during that era. If the low-rate environment was genuinely abnormal, then the assumptions baked into those models could be unreliable guides for the current landscape.
Hammack has also said that 2025 is “not a good time to be preemptive” about interest rate changes. With this much uncertainty about how the plumbing of the financial system actually works right now, the Fed would rather wait and watch data than make moves it might have to reverse.
What this means for markets
Hammack’s emphasis on watching economic data before acting suggests the central bank views inflation risks as the primary constraint on policy, with balance sheet management as an important but secondary consideration.
The acknowledgment that an oversized balance sheet suppresses volatility should make investors think carefully about positioning. If the Fed continues to shrink its holdings, the volatility cushion gets thinner.
The reduction from $9 trillion to $6.7 trillion represents meaningful progress, but the remaining journey is arguably harder. Cutting the first couple trillion was straightforward because reserves were clearly superabundant. The closer the Fed gets to the boundary of adequacy, the higher the stakes of each incremental step. Hammack’s call for gradualism reflects an awareness that overshooting in either direction carries real costs, and that the institution’s tools for detecting the tipping point in real time remain imperfect.
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