The Fed's reserve floor problem: stigma is inflating balance-sheet demand
Stanford economist Darrell Duffie argues the Fed is trapped running higher reserve balances than necessary because banks fear the stigma of using its own liquidity facilities.
After hitting what Darrell Duffie describes as the practical floor on reserve balances in late fall 2025, the Fed had to reverse course and resume growing those balances at roughly $40 billion per month. The proximate cause, in Duffie’s telling, is not some structural feature of the economy. It is stigma: banks perceive that tapping the Fed’s discount window or standing repo facilities signals distress, so they hoard reserves at the open of each day rather than rely on intraday central-bank liquidity.
if they have that perception, that's enough for them to demand a lot of reserves at the start of each day Darrell Duffie
The comparison Duffie draws is instructive. The Bank of England runs a regime where repo rates can be quite volatile and “banks in the UK system are okay with that,” accepting the understanding that they can go to the central bank when needed without penalty to their reputation. The Fed has not cultivated that same acceptance, which means its balance sheet carries a demand premium baked in by perception rather than necessity.
Duffie outlines a rough hierarchy of fixes. Temporary open market operations could trim the average path of reserve balances by perhaps $100 to $200 billion. Two-tiered reserve remuneration, by contrast, would reduce demand by “a lot more than one or two hundred billion dollars,” making it a substantially more powerful tool. The prior question, though, is sequencing: shrinking the balance sheet before tackling the underlying demand problem would, in Duffie’s view, be entirely counterproductive.