The Fed’s Ample Reserves Framework and the Rising Risk of Fiscal Dominance

An ample reserve framework increases the risk that Treasury financing needs will dominate Fed independence.

The Federal Reserve System’s monetary policy mandate—to promote price stability, maximum employment and moderate long-term interest rates—is well established. Prior to the Great Financial Crisis (GFC), in carrying out this mandate the Fed operated within an adequate reserves framework, wherein it targeted a limited level of banking reserves and an interest rate—the federal funds (FF) rate—consistent with the economy’s potential growth rate. Also, under its lender-of-last-resort authority, the Fed provided liquidity during financial stress, withdrawing excess liquidity as markets recovered.

With the onset of the GFC, the Fed’s response, as expected, featured the provision of significant liquidity through large-scale asset purchases (quantitative easing, or QE) and the suppression of short-term interest rates to stimulate the economy. The expectation at the time was that the balance sheet and the FF rate would eventually go back to pre-crisis levels, within an adequate reserves framework.

However, as the crisis receded, the Fed’s policy stance remained highly expansionary, with several rounds of QE and the suppression of both long- and short-term interest rates. From the mid-2000s to the present, the Fed’s reported total assets have risen from under $1 trillion to about $7 trillion. Its portfolio of Treasuries and government-guaranteed securities has expanded from roughly $740 billion to $4.2 trillion, and reserve liabilities have increased from about $9 billion to approximately $3 trillion. This outsized growth in its balance sheet—initially driven by a policy experiment—has caused the Fed to change its policy framework from an adequate reserves framework to a new ample reserves framework.

Under the ample framework, the Fed maintains a large stock of bank reserves, reducing the need for active balance-sheet adjustment, steering policy primarily through administered rates. Coincidentally, the Fed’s operating toolkit broadened beyond QE to include interest on reserve balances, overnight reverse repos and a standing repo facility. The Fed’s footprint within the nearly $12 trillion repo market has also grown dramatically. This new framework developed as an iterative process without a deep analysis of its long-run efficacy or a comparison of its effectiveness relative to that of the framework it replaced.

In time, fiscal authorities realized that QE, the suppression of interest rates, and the growth in bank reserve balances could be used to facilitate the financing of federal debt under the new ample reserves regime. Today U.S. gross federal debt as a percent of GDP is at a historically high level of 120% and is projected to rise significantly higher over the coming decade. Thus, the Fed’s policy and these emerging trends have brought new challenges to the Fed in balancing its relationships with the Treasury and Congress. First among those challenges is that the Treasury’s funding needs may eventually dominate the Fed’s monetary policy.

Notable recent policy episodes highlight this risk. In September 2019, for example, a decline in bank reserves coincided with a sharp rise in repo rates, reflecting liquidity frictions in Treasury debt balances and market flows. The episode prompted the Fed to renew QE and heightened its resolve to assure an adequate liquid market for Treasury securities. This experience underscores the increasing interdependence of Fed balance-sheet policy, market liquidity, and Treasury funding demands in an environment of high and rising public debt.

In this regard, Dallas Fed President Lorie Logan recently proposed that within the ample reserves regime, the FF rate policy target should be replaced with a tri-party general collateral repo rate target. She correctly noted that FF market activity has diminished relative to the secured-repo markets as the latter has grown in size and importance. She argued that such a change would improve policy transmission and the resilience of the Treasury debt market. However, others have observed that an ample reserves balance sheet could reflect the government’s influence on the Fed to monetize its mounting debt. Consistent with this observation would be for the Fed to suppress its target repo rate to keep government borrowing costs low. Both actions would undermine the Fed’s ability to achieve long-term price stability.

As a comparison, history offers lessons in the usefulness of the adequate reserves framework. Post-WWII, for example, saw the U.S. carry a debt burden like today’s, and the Treasury expected the Fed to manage monetary policy and peg interest rates to keep interest costs low. Although controversial at the time, the Fed defied those expectations and stayed with a disciplined reserve policy, enabling it to focus on price stability while the Treasury managed debt issuance. The late 1970s again demonstrated that a credible, disciplined reserves policy was essential to curbing inflation, as seen under Paul Volcker’s leadership. Such historical periods underscore the importance of disciplined monetary governance that is separate from the Treasury’s debt management in the interest of macroeconomic stability.

While monetary policy can be conducted under either an ample reserve or an adequate reserve regime, the question remains as to which serves the nation’s long-term financial stability best. The policy risks seem high as the Fed embraces an ample-reserves policy framework while the nation’s debt continues its climb. Given these risks, the Fed should undertake a more systematic review of which framework yields the best long-term results. Such a review should include:

• A careful, transparent appraisal to judge whether an ample or an adequate reserve regime would better serve the Fed’s dual mandate in the current debt and liquidity environment.

• A structured analysis comparing costs, benefits, transmission channels and resilience under each regime, with explicit attention to policy signals, transparency and protection against fiscal dominance.

Finally, any framework chosen should include governance safeguards that preserve the Fed’s ability to pursue its inflation and employment mandates, leaving Congress and Treasury responsible for managing the national debt.