What is the 'taper'?

In this video, Ed Bowsher explains what the 'taper' is, and how it’s linked to the US quantitative easing programme.

Youve probably heard talk about the taper on TV and in the press. But what exactly is it?

In this video, I explain what the taper is and how its linked to the US quantitative easing programme.

This video really follows on from my last one on quantitative easing or QE.

As a quick recap, QE is when the Bank of England creates new money and buys government bonds. In the US, the Federal Reserve creates fresh money and uses it to buy government bonds and mortgage-backed securities.

We first heard about the taper last summer when Ben Bernanke, who was then head of the Federal Reserve, said he was considering cutting back on the purchase of government bonds. To put it another way, he was going to taper' these purchases.

Bernanke's comments last summer rattled markets. The Fed's money-printing programme has underpinned the rising US stock market for the last few years, so any suggestion that the Fed would cut back on its money printing unnerved some investors.

As a result, Bernanke said his comments had been misinterpreted and he wasn't about to start the taper immediately.

But now six months on, the taper has begun. Instead of spending $85 billion a month on bond purchases, the Fed is now spending $75 billion a month. Not a huge cut, but it's a start.

Interestingly, the cut hasn't unnerved investors this time around. I think the market now accepts that the US is definitely in recovery mode and those signs of recovery provide support for share prices at least in the short term.

We shall probably see further tapering this year, and most likely, bond purchases will have stopped completely by the end of 2014 . That's not certain though. Inflation appears to be falling across most of the developed world and that means deflation is becoming a concern once again.

If the Federal Reserve thinks that deflation has become a serious threat, it might decide to slow down the taper and carry on buying bonds for a longer period.

See also:The lowdown on quantitative easing

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