Tapering
Tapering — is a policy when the central bank stops to inflow money into the economy. The policy of tapering implies control over the percentages, stock purchases, and investment climate. Such a policy should be realized after the economic program of support. The goal of tapering is to smooth the influence of quantitative easing policy.
This policy was developed and carried out in 2008 during the banking crisis. Then, it was effectuated two times — in 2013 and 2021 after the coronavirus pandemic. It was a try to stabilize the market after the high inflation and mass unemployment.
What Is Tapering
Tapering means the reduction of rates after economic stimulation. The expansionary policy should be effectuated because if the monetary stimulation goes for too long it can provoke inflation. For example, the nearest tapering was effectuated after the pandemic of COVID-19 in November 2021.
There is a difference between tapering and tightening. Tapering is an aspect of the loose monetary policy and tightening is the realization of the strict monetary policy. These processes have an equal effect on the interest rate, but they don’t always happen at the same time.
The main goal of tapering is the control of the market expectations. If the Central Bank stops all operations too fast, it may lead to a recession. If it won’t, the inflation will follow. By effectuating the tapering policy the government measures the market expectation to define when it is better to stop. Central banks decrease the volatility and constantly monitor the situation to define when it is better to stop tapering.
When the government tapers, the number of available bonds increases. They become cheaper than stocks and more interesting to potential buyers. It may lead to the fall of the stock market. Also, after the tapering, the rates for mortgage, business, and consumer loans increase.
Tapering and Taper Tantrum
A taper tantrum is a situation that happened in the American financial markets in 2013. The Federal Reserve Board had declared the quantitative easing policy and US Treasury bonds became very profitable very quickly.
Quantitative easing is a type of monetary policy when a central bank buys long-term securities on the open market to increase the stock of money in the country and encourage the investors. Such policy inflows the money into the economy and reduces the interest rates.
Then, the Federal Reserve Board announced that it would slow down the purchases of Treasury bonds to reduce the amount of money it put into the economy. The following rise of bond yields in response to this announcement was called hysteria.
The hysteria was caused by the fear that the market would collapse as a result of quantitative easing being discontinued. In the end, the hysteria panic was unjustified as the market continued to recover from the start of the reduction program.
This alleged policy of slowing down the pace of the Federal Reserve Board's asset purchases came as a major negative shock to investor expectations as the Federal Reserve Board became one of the world's largest buyers. Bond investors reacted immediately to the prospect of a future decrease in bond prices by selling bonds, which caused the bond price to reduce. Of course, falling bond prices always mean higher yields, which is why US Treasury yields have skyrocketed.
There were several reasons the market didn’t decline. First, the Federal Reserve Board didn't slow down the quantitative easing policy. It began the 3rd round of massive bond purchases. Plus, the Federal Reserve Board has expressed strong faith in the market's recovery, which stimulated investor sentiment and actively managed investor expectations. Once investors realized there was no reason to panic, the stock market leveled off.
Pros and Cons of Tapering
Tapering has a strong influence on the financial markets and expectations of investors. Such a policy was rarely conducted because this is a way to weather a financial crisis. It has positive and negative sides. That's why not all economists offer to conduct it. Let’s consider the main pros or cons of tapering.
Pros of Tapering:
- Tapering reduces inflation because it reduces the amount of free money.
- Tapering helps to stabilize the prices for all types of goods.
- Tapering strengthens the currency.
- Tapering increases employment, because when more goods are produced, the richer the population should be to buy them.
Cons of Tapering:
- Tapering increases the rates and slows down economic growth.
- Tapering afflicts damage to GDP, employment, and consumers' expectations.
- Tapering increases the volatility.
- It is hard to choose the time for tapering. Also, it is hard to predict the changes.
As we see, tapering has both positive and negative sides. It is a good way to control monetary policy and avoid inflation. Also, it signals that the bank plans to change the policy from expansionary to more neutral. The tapering creates the balance after the decrease of percentage rates and infusions of money.
