Loretta Mester of the Cleveland Fed was recently quoted as saying that in addition to regular rate hikes this year, she is also recommending that the Federal Reserve begin “winding down” its balance sheet.

I did not note the market reaction to her proclamation nearly as much as I was bewildered by the absence of pushback to the suggestion that the base needs to shrink, because that is what “winding down” the balance sheet means.

The equation of exchange shows what she is saying far better than I can describe it:


Unless Ms. Mester believes in unicorns and the tooth fairy, because the wind down would impact M, and what one does to the left side of the equation one must also do to the right, the more than likely outcome of increasing the downward err with respect to the inflation target and/or inflicting real economic harm is more than apparent. The only way to avoid an undesirable result would be if V were rising at a sustained healthy clip; and while I believe we have seen that in the recent past, it appears to have been partially offset by the promise of more rate hikes in the future, and any boosting effects have leveled off. With all things remaining the same, we end up with scarcely more than the same new mediocre normal, and with attention paid to the bloated balance sheet, we will have some degree of less.

On the philosophical level, I find Mester’s less than reasonable recommendation very hard to understand given the political environment we find ourselves in. At a higher level I question the wisdom and purpose of the participation and supposed societal value of regional Fed presidents on the FOMC given that they are quite detached from accountability to the people they impact.