Federal Reserve Board member Mullan says that shrinking the central bank's balance sheet could take several years.

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Federal Reserve Governor Stephen Milan stated that the U.S. central bank can significantly reduce its balance sheet from current levels, but he warned that this process will likely take several years and need to be carried out in several steps.

In a speech and accompanying working paper released on Thursday, Milan estimated that if policy adjustments are made to reduce banks’ demand for reserves, the Federal Reserve’s asset holdings could potentially decrease by $1 trillion to $2 trillion under the current operating framework. He emphasized that he has not yet reached a clear conclusion regarding balance sheet policy.

“The Federal Reserve’s balance sheet can indeed be reduced, but policymakers should first take steps to ensure that these actions can succeed,” Milan stated in remarks prepared for an event in Miami. “Implementing these steps before beginning to reduce the balance sheet means that there is still some time before real tapering can start.”

Watch: Federal Reserve Governor Stephen Milan stated that the Fed can significantly reduce the size of its balance sheet, but this process may take several years.

Milan emphasized that this process requires adequate preparation, and the Federal Reserve must slow down the pace to allow financial markets time to adjust. He also noted that because reducing central bank bond holdings has a tightening effect, such a move may require “further lowering the federal funds rate relative to the baseline forecast.”

Although Milan did not explicitly advocate for any specific measures, he mentioned that the following options could help reduce the Fed’s “footprint” in the financial system:

• Relaxing banks’ liquidity coverage ratios and related regulatory requirements
• Eliminating the “stigma” associated with using Federal Reserve liquidity tools (including standing repo operations and the discount window)
• Conducting open market operations more aggressively at quarter-end and other key points
• Increasing the liquidity and attractiveness of bank reserve alternative assets (such as U.S. Treasuries)

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Editor: Wang Yongsheng