Federal Reserve Governor Christopher Waller recently offered his perspective on the Fed’s balance sheet, which still stands at over $6.6 trillion. According to Waller, the issue facing the central bank is not the size of the Fed’s balance sheet but the structure of its assets — especially their duration. It’s a compelling case, and it deserves a second look.
Waller claims that the Fed’s liabilities, which include currency, the Treasury General Account (TGA), and reserves held by depository institutions, are inherently safe. Currency pays no interest, has no maturity date, and is irredeemable, because the Fed has no contractual obligation to “convert” currency into any particular good. The TGA has no financial cost to the Fed, as the Fed pays no interest on its balance. Finally, reserves are the most liquid assets in the market, and the Fed can determine the total supply of reserves available by changing the interest rate it pays on them.
The Fed’s recent financial performance, however, casts doubt on the claim that the Fed’s liabilities are inherently safe: the Fed has been making losses since 2022. During fiscal year 2024, the Fed earned $159 billion in interest income while its interest expense on depository institutions, which includes interest on reserves, amounted to $186 billion. As of July 24, 2025, the Fed has accumulated losses of $237 billion.
If the Fed’s liabilities are so safe, why has the Fed suffered losses in recent years?
Waller argues that the risks associated with the Fed’s current balance sheet come from the asset side. The Fed bought large quantities of long-term Treasuries and mortgage-backed securities during its crisis-era quantitative easing (QE) efforts beginning in 2009. It loaded up on even more long-term Treasuries following the onset of the pandemic in 2020. These purchases created a mismatch, since the Fed was essentially funding its short-term liabilities (reserves) with long-term assets. When inflation rose, the Fed had to pay a higher rate of interest on reserve balances in order to bring inflation back down. And, since the rate it paid on reserves exceeded the yield on its (mostly long-term) assets, it suffered losses. But Waller contends this is a problem with QE, not with the ample reserves framework. Had the Fed managed the duration of its assets to more closely match the duration of its liabilities, he claims, it would be in a better financial position today.
In any event, Waller maintains that the Fed cannot go back: “there are external forces that have boosted the size of our balance sheet that are not under the control of the Federal Reserve.” Demand for currency has increased from around $800 billion in 2007 to $2.3 trillion at the end of 2024. The TGA has also increased, from $5 billion in 2007 to between $650 billion and $950 billion in 2024, owing to the Treasury’s 2015 decision to begin holding an estimated week’s worth of federal payments in the TGA. “An important point that applies to both currency and the TGA,” Waller says, “is that the Federal Reserve does not have control over the size of these liabilities and hasn’t been responsible for their sharp increases.”
Together, they represent about $3 trillion of our $6.7 trillion balance sheet, or roughly 10 percent of nominal gross domestic product. So, the size of the Fed’s balance sheet, which is now about 22 percent of nominal GDP, is nearly half accounted for by these two liabilities that are not under the Fed’s control. Those who argue that the Fed could go back to 2007, when its total balance sheet was 6 percent of GDP, fail to recognize that these two factors make it impossible.
Waller added that banking regulations have also “led to a large shift in demand for high-quality liquid assets,” including reserves. Taken together, he says these external forces imply that the balance sheet must be bigger than it was back in 2007.
Waller goes on to say that a larger balance sheet improves the safety of the financial system.
In his opinion, the balance sheet should not only be larger to account for the rise in 1) the demand for currency, 2) the TGA, and 3) the demand for reserves related to regulatory requirements. It should also be larger so that banks can hold reserves beyond those needed to meet their liquidity requirements.
Waller believes an ample-reserves regime where the Fed pays interest on reserves “ensures that there are enough reserves in the banking system to avoid” a “sell-off in Treasury securities, helping to stabilize the financial system without any harm to banks or their customers.” He also believes an ample-reserves regime need not cost the taxpayers any money, so long as the Fed funds its reserves with short-term Treasuries.
As I noted earlier, whether the Fed or banks hold the Treasury securities, the Treasury is paying interest on its debt. And, if the Fed is holding the Treasury securities, then the interest payment from the Treasury to the Fed on the Treasury bills is matched with an interest payment from the Fed to banks on their reserves. So, paying interest on reserves is not creating any additional expense to the Treasury.
Waller compares reserves to clean drinking water: if something is essential and safe, why make it scarce if it can be made abundant at no cost?
In essence, Waller argues that the Fed cannot go back to a small balance sheet and should not go back to a scarce-reserves system. His back-of-the-envelope calculations put the minimum viable balance sheet at $5.8 trillion today, which is around 87 percent of the Fed’s current balance sheet.
Waller makes a strong case. But four counterpoints are worth noting.
First, Waller conflates the Fed’s decision to meet currency demand with not being able to control the supply of currency in circulation. It is true that the Fed cannot control the supply of currency in circulation if it is committed to meeting currency demand. But regardless of its merits, the commitment to meeting currency demand is still a policy choice. If it were not committed to meeting currency demand, it could control the supply of currency in circulation.
Moreover, at least part of the rise in the demand for currency since 2007 is due to the fact that those dollars purchase fewer goods than they did back in 2007. And they purchase fewer goods than they did back in 2007 because the Fed allowed (perhaps unintentionally) the money supply to grow faster than money demand. All else equal, slower reserve growth in 2020 and 2021 would have resulted in less inflation — and a smaller rise in the (nominal) demand for currency. Hence, by controlling reserves, the Fed exhibits some control over currency, as well.
Second, ample reserves present a risk, albeit a small one. While reserves may be ‘backed’ by US Treasuries, the two are not perfect substitutes, as they have different durations. This creates an interest risk that is affected by the size of the Fed’s balance sheet. This risk emerges precisely because the ample reserves regime enables massive balance sheet expansions, which are then exposed to shifting rate environments.
Third, to avoid a knife-edge equilibrium where a random shock might cause the operating regime to switch from ample to scarce reserves, the Fed must include a premium on the interest it pays on reserves. The Fed has been hesitant to approach the minimum viable level to keep reserves ample, suggesting it will ultimately pay a premium sufficient to maintain a sizable buffer. Waller is presumably aware of this hesitancy: after all, he dissented on the slowdown in balance sheet run off back in March. If the requisite premium is sufficiently large, the interest the Fed receives on Treasuries of similar duration will be less than the interest it pays on reserves. Hence, the Fed would have to choose to take losses on the transfers from Treasury to depository institutions or hold riskier assets to make up the difference.
Finally, there’s an overlooked institutional cost. In an ample reserves regime, banks don’t need to borrow from each other. With ample liquidity in the system, the overnight interbank lending market dries up. This removes the incentive for banks to monitor one another — a critical feature of a healthy financial system. In a scarce reserves environment, interbank lending encourages peer oversight, embedding valuable information in market pricing. Ample reserves dilute this mechanism.
Waller’s analogy is thoughtful but problematic. Clean water is safe — until it floods the system and undermines the very structures it was meant to support.
