What does the Federal Reserve mean when it talks about tapering?

He described the balance sheet shrinkage as a process that would be “running in the background” alongside the Fed’s rate hikes. In December 2013, the Fed began to taper, reducing the pace of asset purchases from $85 billion per month to $75 billion per month. Purchases were reduced by a further $10 billion at each subsequent meeting (in February 2014, Janet Yellen took over as Fed Chair). The asset purchase program ended in October 2014, and the Fed began shrinking the balance sheet in October 2017.

On Nov. 3, 2021, Powell announced that the Fed’s monthly purchases would decline to $105 billion in December 2021, with further reductions leading to an eventual goal of zero net additions to the Fed’s bond portfolio by mid-2022. Growing concerns among economists that rising inflation could harm the economy are likely a big part of what https://www.dowjonesrisk.com/ led the Fed to begin tapering. Tapering does not involve selling the securities that the central bank purchased; it’s merely winding down the pace at which those securities are bought. The Fed started tapering its purchases in December 2021 and by the spring of 2021, the economy showed significant strength and a cost-of-living surge.

And so the Fed turned to quantitative easing as a way to continue to reduce borrowing costs. When the government buys assets, their prices go up, which lowers their yield or interest rate. Like all economic stimulus programs, QE policies are not intended to be permanent and after the desired results of an economic stimulus program have been achieved, those policies must be gradually rescinded.

Economists have attributed the rising inflation to pandemic-related imbalances as global supply chain snags and labor shortages hobble the ability of supply to keep up with surging demand, pushing up prices. Tapering is a term used in finance to describe a reduction of monetary stimulus provided by central authorities to the capital markets. However, the Fed did say that in the “longer run,” it plans to hold primarily Treasury securities rather than mortgage-backed securities, because it seeks to minimize its role in allocating credit to different sectors of the economy.

Central banks can hesitate to pull back on their QE policies due to “taper tantrums,” where investors and financial markets overreact to a reduction in stimulus from the central bank. Tapering modifies a central bank’s monetary expansion policies initiated to stimulate an economy. During a program of quantitative easing, a nation’s central bank may buy asset-backed securities from its member banks, injecting money into the economy, to boost recovery. The U.S. central bank began tapering in November 2021, scaling back total purchases by $15 billion a month, from $120 billion to $105 billion. When the Fed began aggressively buying assets in 2020 to help soften the financial impact of the COVID-19 pandemic, it marked a pause in its tapering of asset purchases.

Continuing to stimulate an economy with easy money once a recession has eased can lead to inflation and monetary policy-driven asset price bubbles. By tapering asset purchases, the Fed may help reduce inflation – or at least slow its rise – because it is withdrawing some of the monetary stimulus that is fueling economic growth. Fed tapering introduces uncertainty to the market, a departure from the Fed’s steady asset purchases. That uncertainty could be viewed negatively and thus cause put downward pressure on stock prices.

In December, reacting to surging inflation, the Fed decided to double the pace of tapering, which would bring the bond buying to an end in March. In response to the global financial crisis, the Fed began purchasing Treasury securities and mortgage-backed securities in 2009. The third, launched in September 2012, was open-ended; the Fed said it would keep buying bonds until labor market conditions improved. Tapering is the first step in the process of either winding down or withdrawing from a monetary stimulus program that has already been executed and deemed successful. Communicating openly with investors regarding the direction of central bank policy and future activities helps to set market expectations and reduce market uncertainty. When central banks pursue an expansionary policy to stimulate an economy in a recession, they promise to reverse their stimulatory policies once the economy has recovered.

What is the Fed taper? An economist explains how the Federal Reserve withdraws stimulus from the economy

Specifically, according to guidance the Fed issued in December 2020, tapering was to begin once the economy had made “substantial further progress” toward its goals of maximum employment and price stability. Tapering is the gradual slowing of the pace of the Federal Reserve’s large-scale asset purchases. Tapering does not refer to an outright reduction of the Fed’s balance sheet, only to a reduction in the pace of its expansion. As 2013 drew to a close, the Federal Reserve Board concluded that QE, which had increased the Fed’s balance sheet to $4.5 trillion, had achieved its intended goal, and it was time for tapering to commence. The process of tapering would involve making smaller bond purchases through October 2014.

1. “Substantial further progress” indicates progress made toward maximum employment and price stability, and is how the Fed gauges when to begin the taper.
2. However, long-term rates also reflect market expectations about the course of short-term rates.
3. Tapering refers to the period of reversal between expansionary policy and contractionary monetary policy.
4. QE initially was adopted as a policy response designed to prop up the economy and the securities markets in the wake of the financial crisis of 2008.
5. The third, launched in September 2012, was open-ended; the Fed said it would keep buying bonds until labor market conditions improved.

“We are phasing out our purchases more rapidly because with elevated inflation pressures and a rapidly strengthening labor market, the economy no longer needs increasing amounts of policy support,” Powell said Wednesday. “In addition, a quicker conclusion of our asset purchases will better position policy to address the full range of plausible economic outcomes.” The Fed’s pandemic policies helped stimulate the economy and consumer demand during the height of the crisis, but the U.S. central bank does not have monetary tools to ease the supply constraints. The move to speed up tapering comes as inflation has thrown a new wrench in the Fed’s ability to use its tools to support the economy.

The Fed also put in place a plan to reduce its balance sheet of nearly $9 trillion in asset holdings it accumulated in recent years, mostly Treasury and mortgage-backed securities the beginning of the Fed’s money-tightening measures. Hulbert notes that the Fed traditionally seeks to raise interest rates amid a booming economy to keep it from overheating. In either case, the upshot of his analysis is that economic fundamentals other than interest rates tend to have a bigger impact on stock prices. Indeed, as noted above, the Fed has been sending out signals about tapering for much of 2021. Tapering refers to the Federal Reserve policy of unwinding the massive purchases of Treasury bonds and mortgage-backed securities it’s been making to shore up the economy during the pandemic. In a subsequent press conference, Powell said that tapering would be concluded by the middle of 2022.

Stocks Perform Better When Interest Rates Rise

While the reduction in asset purchases will have a direct impact on the prices or yields of those assets, the bigger implication is what it signifies for the timing of the Federal Reserve hiking policy rates. These tapering announcements have typically resulted in sharp rises in government bond yields, yield curve distortions, and equity market sell-offs. Hence, policymakers are very careful about the timing, pace, and scale of tapering plans. Tapering is shorthand for a gradual end to the massive bond-buying program the Federal Reserve unleashed in early 2020, when the pandemic crashed the economy.

The Fed’s balance sheet ballooned from $4.3 trillion in March 2020 to over $8.9 trillion by May 2022. The Brookings Institution is a nonprofit organization based in Washington, D.C. Our mission is to conduct in-depth, nonpartisan research to improve policy and governance at local, national, and global levels.

When did the Fed stop tapering?

So tapering not only reduces the amount of QE, it is also seen as a forewarning of tighter monetary policy to come, as was observed in the aftermath of the Great Recession. The combination of projected reductions in asset purchases and the possibility of higher rates in 2013 led to a period of high volatility and rising rates in the bond market—an episode that became known as the taper tantrum. To understand how tapering works requires a deeper understanding of quantitative easing.

How Does Tapering Work?

In the two years following the onset of the pandemic in early 2020, the Fed bought over $4.5 trillion in Treasury and mortgage-backed securities. While previous rounds of QE primarily involved the purchase of longer-term securities, during the pandemic, the Fed purchased Treasuries across a broader range of maturities. This was driven by the Fed’s original goal of calming a distressed Treasury market in March and April 2020.

When central banks keep short-term interest rates low, it encourages individual borrowers and businesses to take out loans. On the other side, as central banks like the Fed look to taper, the capital markets closely follow when and how the process will look like. In the US, Federal Reserve Board Chairman Jerome Powell indicated in August 2021 that the Fed is likely to begin tapering before the end of 2021 as part of his annual Jackson Hole speech. By buying U.S. government debt and mortgage-backed securities, the Fed reduces the supply of these bonds in the broader market. Private investors who desire to hold these securities will then bid up the prices of the remaining supply, lowering their yield. This mechanism is particularly important when the Fed purchases longer-term securities during periods of crisis.

Central banks, such as the U.S.Federal Reserve (Fed), can stimulate economic recovery by buying asset-backed securities. This process, along with maintaining a low interest rate, is called “quantitative easing (QE).” But central banks can’t endlessly purchase securities and pump money into the economy. When they believe the economy has recovered sufficiently, they work on winding down asset purchases or “tapering.”