Bill Nelson on the Future of the Fed's Balance Sheet

**David Beckworth** (0:02)
Welcome to Macro Musings, where each week we pull back the curtain and take a closer look at the most important macroeconomic issues of the past, present and future. I am your host, David Beckworth, a senior research fellow with the Mercatus Center at George Mason University. And I'm glad you decided to join us. Our guest today is Bill Nelson. Bill is the Chief Research Officer and Chief Economist at the Bank Policy Institute. He is also the former Deputy Director of the Division of Monetary Affairs at the Federal Reserve Board. Bill joins us today to discuss some recent research on the structural demand for reserves, as well as some updates on the Fed's balance sheet and his testimony on that issue before Congress. Bill, welcome back to the program.

**Bill Nelson** (0:49)
Thanks for having me, David. It's always a pleasure.

**David Beckworth** (0:51)
Bill, this is Appearance Number 10

**Bill Nelson** (0:55)
That's crazy.

**David Beckworth** (0:56)
It is.

**Bill Nelson** (0:56)
That's really surprising.

**David Beckworth** (0:57)
And that means you get an official golden jacket. Although we haven't issued one yet, we will be the first. George also is entitled to one, George Selgin, but 10 times. And the reason it's been so many times is because this is an issue that we've talked about before, the Fed's balance sheet, the operating system, the structural demand for reserves. So if this issue continues to be something that doesn't get addressed, I'm sure you'll be back on for 10 more.

**Bill Nelson** (1:22)
Well, maybe it doesn't feel like 10, because I love talking about these things, and I love sitting here talking with you, David. You always make it very natural and easy.

**David Beckworth** (1:29)
Well, I have learned so much from you, and I appreciate you taking time out from your busy jobs to come over here and discuss it. And one of the things I do is I have you on. Sometimes I go out to eat with you, but I also follow your newsletter. You have a really good newsletter that you sent out on the email list, and I was thinking maybe the listeners and the watchers may want to know about it. How can they get on that list?

**Bill Nelson** (1:51)
It's simple. They just need to email me at bill.nelson at dpi.com and ask to be added to the distribution list. It's free, and I'll be happy to add them.

**David Beckworth** (2:01)
Okay. And I encourage people to do that because it is very educational. I've learned a lot and it's helped shape some of my thinking, some of the issues that I follow. All right. So Bill, last time you were on the show was, I believe, early last year in 2025 So it's been a while, a lot has happened, and probably the biggest balance sheet development since then is that we've come to the end of Q2. We saw an end to it. We came from a high of $8.9 trillion, the size of the Fed's balance sheet down to 6.5 when they stopped earlier this year. And once again, we see a QE ratchet effect.

**Bill Nelson** (2:35)
Right.

**David Beckworth** (2:36)
Now, it's important to note, and you know this, but for some listeners and watchers of the video, it's important to note that even though the reserves did fall significantly, the ending level is still higher than the starting point. So it may be a little confusing when I say there's a ratchet effect. You got to look at the level of reserves at the starting point, ending points, not at the peaks and the downturns, right?

**Bill Nelson** (3:00)
That's right. And it's a bit deceptive this time because a lot of the runoff in the assets actually corresponded to a reduction in the ONRRP facility, the facility that the Fed provides to money funds basically to invest in the Fed. So that's a source of funding and it's a liability and that most of the decline in their asset holdings during QT was actually matched by a rundown in the ONRP facility. So if you look at reserve balances, they've kind of bounced around between 3.1 or 2 and 2.8 trillion. So where they are now, the ratchet is firmly entrenched.

**David Beckworth** (3:37)
So the ratchet effect deals specifically with the level of reserves, whether it's an absolute level or even relative to GDP. And you had a nice table and a recent note, we'll link to it in the transcript, but just to maybe to put some numbers to this claim of the QE ratchet effect. So of course, April 2008, before we go to the ample reserve system, the Federal Reserve's own estimates of the structural demand for reserve is 35 billion. Those were a long time ago, simpler times. November 2016, you note that they have it at 300 billion. November 2018, it jumps to 1 trillion. October 2019, before we get to QE under COVID, it was 1.4 trillion, and now it's around 3 trillion. That's just the reserves. This doesn't include the other liabilities.