Contrary to the push for an "efficient" (smaller) Fed balance sheet, an abundance of reserves increases bank safety. Bank reserves are immediately accessible liquidity, unlike Treasuries which must be sold or repoed in a crisis. This inherent buffer can make the banking system more resilient.
The Fed uses qualitative terms like "ample," "abundant," and "excess" to describe bank reserve levels without providing concrete, numerical definitions. This linguistic ambiguity allows for policy flexibility but creates uncertainty for market participants trying to precisely gauge the central bank's stance.
Despite the average American holding only about $60 in cash, the per capita amount of U.S. currency is over $7,000. This is because the vast majority—as much as five-eighths—of physical U.S. currency, particularly $100 bills, is held offshore as a global store of value.
The Fed's "ample reserve" system has fundamentally changed the Fed funds market. Banks no longer need to borrow reserves from each other. The market is now dominated by non-U.S. banks borrowing from home loan banks in a simple arbitrage trade, making it a poor barometer of liquidity.
Quantitative Easing (QE) forced massive, often uninsured deposits onto bank balance sheets when loan demand was weak. These deposits were highly rate-sensitive. When the Fed began raising rates, this "hot money" quickly fled the system, contributing to the banking volatility seen in March 2023.
Dallas Fed's Lori Logan has signaled a potential shift away from targeting the Fed funds rate. As the Fed funds market has become inactive and is no longer a true market, targeting a traded repo rate would provide better real-time feedback on liquidity and policy implementation.