MNI: Fed’s Logan Says QT Imperative To Help Contain Inflation

The Federal Reserve’s effort to shrink its balance sheet is key to bringing inflation back under control and ensuring a level playing field in the cost of liquidity between banks and non-banks, Dallas Fed President Lorie Logan said Friday.

“While acquiring assets during a severe downturn or in response to severe market dysfunction can provide much-needed support for the financial system and economy, holding the assets too long can undermine the achievement of monetary policy goals,” Logan told an ECB conference in a speech that focused on reserve management and did not make direct reference to the outlook for monetary policy.

“Maintaining overly large asset holdings may push inflation above target or may complicate the calibration and communication of the policy stance, which ordinarily should center on the policy rate.”

The Fed has raised interest rates sharply in the last 18 months to a 22-year high of 5.25-5.5%. It has also shrunk its balance sheet by over USD 1 trillion to around USD7.8 trillion. (See MNI: Forks In Road Ahead For Fed's QT Plan-Ex-Staff)

Another reason for the undertaking is to make sure the cost of liquidity in money markets is not unduly distorted, she said.

“By acquiring non-reserve assets to back reserves, the central bank adds to the supply of liquidity for banks but may increase non-banks’ cost of liquidity,” Logan said. But in an efficient system, the costs of liquidity should be similar for banks and non-banks. Significant differences in liquidity costs imply that liquidity is too abundant for one type of firm or too scarce for another.”

DISCOUNT WINDOW

She argued the Fed might need to modernize its discount window facility in order to make sure all banks have access to it and a way to access it quickly – whenever they might need it.

“The Federal Reserve should consider expanding the hours of critical services such as the discount window. With the launch of instant payments services such as FedNow, liquidity in the U.S. and other markets is increasingly a 24/7/365 business,” Logan said.

“Our liquidity backstop should be available whenever banks may need it. Over time, that could include nights, weekends and holidays, not just business days.”