Too embarrassed to ask: what is tapering?

Tapering is the reduction in quantitative easing provided by a central bank. But how does it work?

The financial world has a habit of coining new definitions for old words, and then constantly referring to these new usages as if everyone should know what they mean.

One relatively recent such coinage is “tapering”. 

“Tapering” relates to central bank policies. 

Since 2009 and the great financial crisis, central banks have been printing money to buy assets such as government bonds. 

This is known as “quantitative easing”, or QE. The aim – or at least, one of the aims –  of QE is to reduce the cost of borrowing across the entire economy. This makes it cheaper for those with debts to pay their interest bills. 

It should – in theory at least – also make it more appealing for companies to borrow money to invest in expanding their businesses. This in turn should help to boost economic growth. 

However, another side-effect of QE has been to drive up asset prices across the board, from bonds to shares to property prices. 

As a result, investors tend to like it when central banks add more QE, but aren’t so happy when they reduce it.

It’s not entirely clear who actually coined the term “tapering”, but it sprang into widespread use after May 2013. 

That month, Ben Bernanke, who was then the head of the US central bank – the Federal Reserve – indicated in a speech that the central bank was starting to consider reducing the volume of assets that it was buying via QE.  

So “tapering” simply describes a reduction in the amount of QE a central bank is doing. 

Markets didn’t like this idea, fearing that less QE would spell lower asset prices. The ensuing period of turbulence became known as the “taper tantrum”. This resulted in the Federal Reserve taking several months longer than expected to slow down the pace of QE.

The term “taper” is becoming relevant again today because central banks are now looking at stepping back from the emergency monetary policy they launched during the coronavirus pandemic.

Whether we will see a repeat of the 2013 “taper tantrum” or not, remains to be seen. 

To learn more about monetary policy and markets, subscribe to MoneyWeek magazine.

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