What’s a Taper? Why Are Central Banks Debating Them?
(Bloomberg) -- These days, if you hear economists arguing about “the taper,” chances are they’re not talking about pants or haircuts but about central banks. The question is when the U.S. Federal Reserve and its global peers, including the European Central Bank, will start to pull back on the massive bond-buying programs they unleashed in 2020, when economies staggering under the pandemic needed all the stimulus central banks could give. Alongside that is whether it can be done without triggering the kind of “taper tantrum” that roiled markets worldwide in 2013 when the Fed hinted at an end to a similar program that had started during the global financial crisis.
1. What’s a taper?
That’s the term Fed officials (and others) use to describe a plan to take their foot off the gas gradually, by trimming bond purchases over an extended period. The hope is to wean the economy slowly off the extra stimulus the purchases provide to avoid a crash landing.
2. What has been happening?
As markets reeled from the start of the pandemic in March 2020, Fed officials announced that the bank would buy $200 billion of agency mortgage-backed securities and $500 billion of Treasuries. Initially, that was described as a way of helping to maintain market liquidity. In December 2020, officials said the bank would purchase $80 billion a month in Treasuries and $40 billion a month in mortgage securities until there was “substantial progress” in the economic recovery. Between early March 2020 and late August 2021, the Fed raised the value of the assets it holds from $4.2 trillion to $8.3 trillion.
3. What’s the idea?
The Fed’s usual method of fighting recessions is to push down the interest rates banks charge each other for overnight loans, which allows banks to offer cheaper loans to businesses and consumers, thereby stimulating economic activity. But in the wake of the 2008 financial crisis, the Fed realized that cutting its rate virtually to zero was not medicine enough. So the Fed began buying bonds in hopes of driving down long-term rates that are usually outside its control, in a program it called quantitative easing.
4. Had that ever been done before?
Yes, but never on such a massive scale. In the six years that followed the 2008 financial crisis, the Fed bought more than $3.5 trillion in bonds. Other central banks had similar programs at the time, including the Bank of Japan, the European Central Bank, and the Bank of England. The European Central Bank and the Bank of Japan never stopped the bond purchases they started after the financial crisis, and stepped up their buying after the pandemic hit in the spring of 2020.
5. What was the ‘taper tantrum’?
When then-Fed Chairman Ben Bernanke suggested in May 2013 that the central bank was just considering scaling back its bond purchases, financial markets took fright. The subsequent rise in long-term interest rates hit the U.S. housing industry and emerging markets hard.
6. How did the taper work that time?
It took 10 months. The reductions were announced in December 2013 and began the following month, with the Fed detailing cuts by $10 billion at each policy-setting meeting, divided evenly between Treasuries and mortgage bonds. The Fed wrapped up all the buying in October 2014 and went on to lift rates in December 2015 after keeping them steady for seven years.
7. Why is a taper being discussed again?
The U.S. economy rebounded strongly in the first half of 2021, as vaccinations took hold and the disruption caused by the pandemic eased, leading investors to wonder when some of the Fed’s stimulus would be rolled back. Most Federal Reserve officials agreed in July they could likely start slowing the pace of bond purchases this year. Fed officials say they are trying to be as transparent as possible about their plans to avoid a repeat of the surprise that set off the taper tantrum. “We are talking about talking about tapering,” San Francisco Fed President Mary Daly said in a CNBC interview on May 25. In a virtual speech to the bank’s annual summer conference, Fed Chair Jerome Powell said that strong employment reports suggested that a taper could begin in 2021, though he added that the bank would also be assessing the damage from the spread of the coronavirus delta variant.
8. What’s at stake?
A lot, with the gusher of cash awash in the financial system helping to drive U.S. stocks and housing prices to record highs and Treasury yields holding just above six-month lows. Markets will be watching not only when the Fed begins to taper, but the pace at which it does so. Pulling back too quickly could derail the economic recovery just as the surge in the delta variant is posing a new risk of extending the health crisis. Moving too slowly could fuel the inflation pressures unleashed by the reopening from the pandemic.
9. Are other central banks following suit?
ECB President Christine Lagarde promised in July that the Frankfurt-based central bank had learned from past crises and wouldn’t derail the euro area’s economic recovery by withdrawing emergency support too early. The ECB has been purchasing debt at an average pace of 80 billion euros ($94.6 billion) a month and has about half a trillion euros left to spend under its 1.85 trillion-euro emergency program. In September, the bank said that it would slow the pace of its pandemic bond-buying program in the final quarter of 2021, a shift Lagarde insisted wasn’t a taper in that it didn’t herald a wind-down in stimulus for the euro-region’s still-vulnerable recovery.
The Reference Shelf
- More QuickTakes on the Fed’s original taper, how the Bank of Japan handled taper speculation, how central banks responded to Covid-19, negative-yielding bonds, and what quantitative tightening is.
- Bloomberg Opinion’s Marcus Ashworth on why the Fed is watching the BOE, Daniel Moss assesses Australia’s stance, and Mark Gilbert argues the ECB should stand pat.
- The Brookings Institution goes deeper into the Fed and tapering.
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