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.

Recommended

Julian Brigden: markets are at a huge inflexion point
Investment strategy

Julian Brigden: markets are at a huge inflexion point

Merryn talks to Julian Brigden of Macro Intelligence 2 Partners about the unwinding of the US stockmarket's super-bubble, and the risks and opportunit…
25 Jan 2022
Has growth investing had its day? Don’t be so sure
Growth investing

Has growth investing had its day? Don’t be so sure

Markets – and “jam tomorrow” growth stocks in particular – continue to crash, with some analysts forecasting a 50% drop or more. But, says Max King, a…
25 Jan 2022
A cheap investment trust with a good record
Investment trusts

A cheap investment trust with a good record

This cheap investment trust’s yield of almost 9% may look too good to be true, but should be sustainable, says Max King.
25 Jan 2022
Tax return deadline extended – but don't forget to file
Income tax

Tax return deadline extended – but don't forget to file

HMRC is being slightly more lenient about tax returns this year, but falling behind will still incur hefty fines.
25 Jan 2022

Most Popular

Shareholder capitalism: why we must return power to listed companies’ ultimate owners
Investment strategy

Shareholder capitalism: why we must return power to listed companies’ ultimate owners

Under our system of shareholder capitalism it's not fund managers, it‘s the individual investors – the company's ultimate owners – who should be telli…
24 Jan 2022
Ask for a pay rise – everyone else is
Inflation

Ask for a pay rise – everyone else is

As inflation bites and the labour market remains tight, many of the nation's employees are asking for a pay rise. Merryn Somerset Webb explains why yo…
17 Jan 2022
Three innovative Asian stocks to buy now
Share tips

Three innovative Asian stocks to buy now

Professional investor Fay Ren of the Cerno Pacific Fund highlights three of her favourite Asian stocks to buy now
24 Jan 2022