QT, Ample Reserves, and the Changing Fed Balance Sheet

The Federal Reserve’s Federal Open Market Committee (FOMC) influences market interest rates by changing the administered rates that it controls, such as the interest rates on overnight repurchase and reverse repurchase agreements. This requires an ample level of bank reserves. Quantitative tightening (QT) reduces the level of reserves. To guard against supply and demand shocks that drive reserves too low, the FOMC may need to hold a buffer above the point at which reserves become scarce. In this Economic Commentary, I present evidence based on inventory theory that the estimated buffer might be relatively small, though the true number is uncertain. Treating the Federal Reserve’s balance sheet as inventory helps to estimate the level of reserves needed to stay above the scarce threshold.