The Fed is going to start tapering. What is Tapering & how does it affect the economy?

Tapering is the reduction of the rate at which a central bank accumulates new assets on its balance sheet under a policy of QE or Quantitative Easing. Tapering is the first step in the process of either winding down—or completely withdrawing from—a monetary stimulus program that has already been executed.

When central banks pursue an expansionary policy to stimulate an economy in a recession, especially during a global crisis like the Covid 19 Pandemic, they often explicitly promise to reverse their stimulatory policies once the economy has recovered. This is because continuing to stimulate an economy with easy money once the recession is over can lead to out-of-control inflation, monetary policy-driven asset price bubbles, and an overheated economy.

An increasing number of Fed governors have been publicly promoting a start to taper before the end of this year, with some advocating a “go early and go hard” approach against the backdrop of a US inflation rate that is higher than it has been for 30 years.

And in July, the Federal Reserve officials made plans to pull back the pace of their monthly bond purchases likely b-efore the end of the year, meeting minutes released Wednesday indicated.

“Looking ahead, most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year,” the minutes stated, adding that the economy had reached its goal on inflation and was “close to being satisfied” with the progress of job growth.

However, committee members broadly agreed that employment has not met the “substantial further progress” benchmark the Fed has set before it would consider raising rates.

Addressing interest rate concerns, committee members also stressed the need to “reaffirm the absence of any mechanical link between the timing of tapering and that of an eventual increase in the target range for the federal funds rate.”

Fed officials have oft repeated that tapering will happen first, with interest rate hikes unlikely until the process has been completed and the central bank isn’t growing its balance sheet anymore.

Today we see volatile share markets around the world, bond yields sliding, & the US dollar strengthening. Commodity prices also corrected after the release of the Fed’s Open Market Committee meeting minutes. Most of the members are prepared to start “tapering” the Fed’s approximately $US120 billion a month of bond and mortgage purchases, starting later this year! We must watch out for this.

MIMI PARTHA SARATHY
Managing Director,
Sinhasi Consultants Pvt. Ltd.

While the message about tapering has been taken there are concerns in the market that the Fed might be unwavering in executing it even if the economy sours.

Officials judged that “uncertainty was quite high” about the outlook, with the Covid-19 delta variant posing one challenge and inflation another. Some members noted “upside risks to inflation,” in particular that conditions Fed officials have labeled as transitory might last longer than anticipated.

Bibliography

Taper tantrum fears: Fed chair has to be careful not to unleash market chaos, THE SYDNEY MORNING HERALD | Federal Reserve preparing for taper this year, July minutes show, CNBC | Why Jay Powell should be bold at Jackson Hole, FINANCIAL TIMES | MPC Minutes: Jayant Varma ensures turn to normal, CNBC TV18