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“As a student of these businesses for decades, I would bet you that 2021 is not the ceiling,” Goldman Sachs Group Inc. CEO David Solomon said, referring to the last record year for lenders’ trading businesses. “The world is set up at the moment to be incredibly constructive in 2026 for M&A and capital markets activity, and I think the likely scenario is it is a very, very good year.”

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The Federal Reserve has stopped shrinking its massive $6.5 trillion portfolio, sparking a critical debate over its ideal size. According to the central bank's own economists, this decision involves a fundamental trade-off that pits competing policy goals against each other.

In a recent paper, Fed researchers Burcu Duygan-Bump and R. Jay Kahn argue that central banks face a "balance sheet trilemma." This framework highlights the tension between the financial sector's demand for reserves and sudden shifts in market liquidity.

Understanding the Core Conflict

The trilemma suggests that a central bank can successfully achieve only two of the following three objectives at any given time:

• A small balance sheet

• Low interest-rate volatility

• Limited market intervention

The Fed’s decision to halt its balance sheet reduction in December followed a three-year effort. The move came after stress signals emerged in the $12.6 trillion short-term money markets, indicating that bank reserves were no longer abundant.

To manage these pressures, the Fed announced last month it would begin reserve management purchases to ensure its stock of reserves remains at an ample level while money market rates are elevated.

A Balance Sheet Swelled by Crisis

The Fed's current portfolio is a legacy of its responses to major economic shocks. Its balance sheet expanded from just $800 billion nearly two decades ago to a peak of $8.9 trillion in June 2022. This growth was driven by large-scale asset purchase programs launched during the 2008 global financial crisis and the COVID-19 pandemic.

Since 2019, the central bank has operated under an "ample-reserves regime," holding a large portfolio of Treasuries. Under this system, it pays interest on reserves that banks park with it and on cash that money market funds place at the Fed.

However, officials remain divided on the long-term strategy. Fed Vice Chair for Supervision Michelle Bowman, for instance, has advocated for shrinking the balance sheet as much as possible to return it closer to pre-crisis levels.

Three Competing Policy Paths

The trilemma forces policymakers to choose a strategy, with each option carrying significant consequences for financial markets.

Path 1: Maintain a Large Balance Sheet

A large balance sheet can act as a structural cushion, providing safe and liquid assets that prevent short-term rate volatility. This approach reduces the need for the Fed to conduct regular market interventions. The downside is a large and permanent central bank footprint in financial markets.

Path 2: Operate with Leaner Reserves

Shrinking the balance sheet would increase volatility in money markets, forcing participants to adapt to liquidity pressures on their own. However, the authors of the paper warn this could weaken the Fed's control over interest rates and complicate the transmission of monetary policy, particularly during an unexpected shock.

Path 3: A Hybrid Approach

Policymakers could also choose a middle path, tolerating some rate volatility around predictable events like quarter-end reporting dates. In this scenario, the Fed would respond with targeted market operations and maintain a slightly larger balance sheet. The risk, however, is that frequent interventions could distort market signals, creating problems similar to those associated with a permanently large balance sheet.

An Unresolved Question for the Fed

Ultimately, the choice of strategy will define the Fed's role in the market. As the economists noted, regardless of the path chosen, "the central bank will almost always have a footprint," either through its holdings or its market operations.

The appropriate long-term size of the balance sheet remains an open question, with no clear consensus among economists or policymakers.

Chicago Fed President Austan Goolsbee delivered a stark warning on Thursday, stating that any attempt to weaken the Federal Reserve's independence could unleash a new wave of inflation.

"Anything that's infringing or attacking the independence of the central bank is a mess," Goolsbee said. "You're going to get inflation come roaring back if you try to take away the independence of the central bank."

Goolsbee's comments come as Fed Chair Jerome Powell confirms he has been served a subpoena by the Justice Department. The investigation relates to a major renovation of the Federal Reserve's headquarters in Washington, D.C.

Political Pressure Intensifies on Fed Leadership

The Chicago Fed president supported Powell’s recent assertion that the investigation could be a pretext for Donald Trump to exert influence over interest rate policy.

Trump has consistently criticized Powell, using insults and publicly demanding lower rates. This pressure has continued even though the Fed has already cut its main interest rate three times since September 2025. Trump has nicknamed the Fed chair "Too Late," signaling his dissatisfaction with the pace of monetary easing.

While Powell's term as chair is set to end in May, he is eligible to remain a Fed governor until 2028.

The Global Precedent for Central Bank Independence

Goolsbee, who joined the Chicago Fed in December 2022, directly addressed the unusual nature of a government investigation into its own central bank. He argued that such actions are not characteristic of stable, advanced economies.

"I know that there have been countries that had criminal investigations of their central banks," he noted. "But those countries are Zimbabwe and Russia and Turkey and a bunch of places that you would not characterize as advanced economies."

The underlying principle is that when a central bank loses its political independence, its credibility erodes. Historically, a loss of central bank credibility is often followed by a rise in inflation as the public loses faith in the institution's commitment to price stability.

A Defense of Powell's Record

Goolsbee, who previously served as an advisor to Barack Obama and Joe Biden, emphasized that his political past is irrelevant to his current role. "Once you've become a sworn member of the Federal Reserve, you're out of the elections business," he stated.

He also offered a strong endorsement of Powell's performance, calling him a "first-ballot Hall of Famer" for successfully bringing down inflation without triggering a recession. Goolsbee's comments frame the current conflict not just as a political dispute, but as a fundamental threat to the economic stability Powell has worked to achieve.

International Monetary Fund (IMF) chief Kristalina Georgieva has publicly defended the principle of central bank independence and offered her support for Federal Reserve Chair Jerome Powell, who is currently facing an investigation by the Trump administration.

Figure 1: IMF Managing Director Kristalina Georgieva has voiced strong support for the Federal Reserve's independence amid political pressure.

In a Thursday interview with Reuters, Georgieva stressed that substantial evidence shows independent central banks serve the best interests of both businesses and households. She argued that evidence-based, data-driven decision-making is fundamentally good for the economy.

Voicing her personal respect for the Fed Chair, the IMF managing director stated, "I have worked with Jay Powell. He is a very good professional, a very decent man, and I think that his standing among his colleagues tells the story." Her comments align with a letter of support for Powell signed by her predecessor, European Central Bank head Christine Lagarde, and other major central bank leaders.

The Investigation into the Fed Chair

The show of support comes after Powell revealed on Sunday that the Trump administration has launched an investigation into him. The probe focuses on cost overruns related to a $2.5 billion project to renovate two historic buildings at the Fed's Washington headquarters.

Powell has denied any wrongdoing, describing the administration's actions as a pretext to pressure him for not yielding to President Trump's repeated demands for significantly lower interest rates.

This unprecedented move against a sitting Fed Chair has triggered widespread criticism from several key Republican senators, foreign economic officials, investors, and former U.S. government officials from both political parties.

Trump's Stance on Fed Independence

President Trump has frequently criticized Powell's leadership at the Federal Reserve, often launching personal attacks over the pace of interest rate cuts.

On Wednesday, Trump dismissed concerns that eroding the central bank's independence could weaken the U.S. dollar and fuel inflation. When asked about these risks by Reuters, he replied, "I don't care."

The pressure extends beyond Powell. Trump has also sought to fire another Fed official, Governor Lisa Cook, who is challenging her termination in a legal case scheduled to be heard by the Supreme Court next week.

Global Implications for Monetary Stability

Georgieva noted that the IMF closely monitors issues like monetary and financial stability, as well as the institutional strength of member countries. The Federal Reserve receives special attention given the U.S. dollar's crucial role as a global reserve currency.

"It would be very good to see that there is a recognition ... that the Fed is precious for the Americans," she said. "It is very important for the rest of the world."

The International Monetary Fund (IMF) is preparing to seek board approval for a new $8.1 billion lending program for Ukraine within weeks, according to Managing Director Kristalina Georgieva. The announcement signals a major step in securing critical funding for the war-torn country's economy.

Speaking after high-level meetings in Kyiv with Ukrainian President Volodymyr Zelenskiy and other senior officials, Georgieva emphasized that while the fund is adapting to Ukraine's evolving situation, the core requirements of the program remain firm.

IMF Managing Director Kristalina Georgieva discussed the terms of a new lending program during a visit to Kyiv.

"I'm here to see how the country is doing in these unusually harsh times, because I want to make sure that what was agreed in November is implementable as it was agreed," she said. "We recognize that the direction to travel remains the same (but) the way we take these steps, we have to calibrate carefully."

The Key Condition: Ending VAT Exemptions

A central condition for the new program is Ukraine's commitment to press forward with removing a value-added tax (VAT) exemption for consumer goods, a policy that has faced domestic resistance. Georgieva described the reform as a "must-have" requirement.

However, the IMF is showing some flexibility on the timeline. Before the new program can be approved, the fund will only require that the measure is introduced in parliament, not that it has already been passed into law.

"On the VAT exemptions, we made it very clear that this has to happen," Georgieva stated. "We cannot possibly have the Ukrainian economy lingering between market economy and non-market economy."

A Non-Negotiable Step Toward a Market Economy

The IMF chief stressed to Ukrainian officials that the VAT reform is non-negotiable and essential for the country's long-term economic health and strategic goals.

"I was very clear. You know, this, you cannot touch it," Georgieva explained. "You need it for you. You need it for EU accession. You need it to attract the private sector to make the business environment more conducive."

The fund plans to assess which required measures can be implemented quickly and which need to be "calibrated" more carefully given the circumstances. In a sign of this calibrated approach, the IMF is discussing a one-year timeframe for Ukraine to build the necessary parliamentary support to pass the controversial tax law.

Source: Yahoo finance