- Key insight: Attempts to return the Fed's balance sheet to pre-financial crisis size were ineffective and forward guidance tied the central bank's hands coming out of the pandemic, a Brookings Institute-commissioned paper on Powell-era monetary policy found.
Federal Reserve Board Chair Jerome Powell. Photographer: T.J. Kirkpatrick/Bloomberg Andrew Harrer/Bloomberg - Expert quote: "Although it is superficially tempting to want to return to the days of a small balance sheet and low reserves, the turbulence of September 2019 and the reasons for that turbulence show that doing so without major institutional changes is simply not possible." – Christina and David Romer, economists at the University of California, Berkeley.
- Forward Look: The report's key findings speak to two of newly installed Fed Chair Kevin Warsh's top priorities: reducing the central bank's balance sheet and its volume of external communication.
An analysis of the Federal Reserve's monetary policy record under former Chair Jerome Powell carries two lessons for the
University of California, Berkeley economists Christina and David Romer analyzed the Fed's monetary policy actions from February 2018 to May 2026 to determine their motivations, reasonableness and ultimate impacts. In a
"In the Powell era, monetary policy was most successful when it was driven by a conventional framework focused on managing aggregate demand to reach the Fed's inflation target and the maximum level of employment consistent with price stability," they wrote. "Monetary policy has been least successful, not just in the Powell era but in generations before, when it was based on less solid theories and sought to solve social problems or reach unrealistic goals…"
Two of the lessons the Romers surmised from the analysis — which spanned eight years of Federal Open Market Committee meeting minutes, policy statements and, when available, transcripts — spoke directly to priorities outlined by Powell's successor,
Warsh has advocated for significantly reducing the Fed's balance sheet, which expanded from less than $1 trillion in 2008 to nearly $9 trillion during the covid-19 pandemic. The Fed's holdings have since fallen to $6.7 trillion, but Warsh has advocated bringing it back to its pre-global financial crisis size.
The Romers argue that a major reduction in the Fed's balance sheet is risky and unnecessary. They say the interest rate volatility of September 2019 — when reserves in the banking system became scarce amid the central bank's first balance sheet reduction campaign — demonstrated the challenges inherent in balance sheet reduction.
Returning to the 2008 balance sheet size would require "greatly reducing or completely eliminating both bank liquidity requirements and interest on reserves," the concluded, changes that would disincentivize prudent balance sheet management and could result in financial intermediation activity migrating outside the banking system.
"Together, these observations suggest that although there may be changes that would pass a cost-benefit test that would shrink the Fed's balance sheet somewhat, there would be substantial downsides and no significant upsides to attempts to shrink its size greatly," they wrote.
Warsh has also called for scaling back certain communication practices, including projections from the Federal Open Market Committee and forecasts from individual governors. The Romers' report backed this approach, critiquing the Fed's communication practices under Powell.
Forward guidance has been embraced by central banks around the world during the past two decades as a tool for influencing long-term interest rates and smoothing the transmission of policy changes. But, at various times during the past eight years, the Romers found, the practice appeared to keep the Fed wedded to policies for too long. Specifically, they pointed to the Fed's commitment to keep interest rates at the lower bound until the labor market was at full capacity and inflation returned to 2% putting the FOMC in a bind coming out of the pandemic.
The Romers concluded that forward guidance belongs in the Fed's toolbox, but should be used more judiciously.
"First, because it always runs a risk of influencing future decisions in undesirable ways that were not anticipated, the bar for using it should be high," they wrote. "And second, it should be crafted with a wide range of possible paths for the economy in mind, not just the most likely ones."
Direct monetary policy decisions aside, the report praised Powell's commitment to maintain the Fed's independence in the face of harassment and threats from President Donald Trump. For his effective leadership on this front, the Romers said Powell is a "hero" to economists and worthy of gratitude.
For this independence to continue, they concluded, the institution will need support from Congress, the courts and the broader public.
"When Powell took office, the importance of central bank independence was well established and Fed independence seemed secure," they wrote. "But the past eight years have provided surprising—if not shocking—evidence of the extent to which independence is at risk, and a vision of how dramatically loss of independence could affect policy."
