You may hear a lot about ‘tapering’ in the coming months. The obvious meaning of tapering is that something is becoming thinner or narrower.
By extension, ‘tapering’ is used in a financial sense and means the winding down of an existing monetary stimulus programme. As a result of COVID, governments around the world have injected money into the system to help fend off an economic downturn.
Following the 2008 financial crash, central banks embarked on what they called ‘Quantitative Easing’ (QE). QE involves a central bank doing large-scale buying of assets such as government and private sector bonds, mortgage-backed securities, even stocks. The Bank of Japan has been using QE for around 20 years. The US Federal Reserve had three rounds of QE between 2009-14 buying $4 trillion of ‘assets’ such as US Treasury bonds, stocks. The European Central Bank (ECB) is currently buying €21.1 billion of private and public sector bonds and other assets. The UK’s Bank of England has a similar policy.
The US Federal Reserve currently buys $120 billion of bonds each month. Governments and central banks hope that such massive injections of liquidity into the system will prevent deflation, economic collapse, and will encourage the business world to invest more for future growth. However, QE is still at the experimental stage – no-one knows for sure that it works, nor how much it stokes inflation. As Stephen Williamson, former economist at the Federal Reserve Bank of St. Louis, has written: “QE is controversial, the theory is muddy and the empirical evidence is open to interpretation, in part because there is little data to work with”.
And now, with inflation levels rising, the US Fed is starting to re-think its current $120 billion a month purchases. It has started talking about ‘tapering’, i.e. reducing its level of bond buying, and possibly raising interest rates. Wider investment markets have been buoyed in the past few years by the very lax monetary policies of governments. A reduction in asset purchases by central banks – a ‘tapering’ – will signal the start of higher interest rates, and a tightening in money supply; credit will become more expensive, and the prices of assets (such as houses) are likely to stop rising so fast.
Governments believe that QE has kept their economies from suffering worse than they have under Covid. They worry that if they start ‘tapering’ – or even begin to talk about it – then confidence might be damaged. We are in a period of deep uncertainty; when will the current round of QE start to taper off? The ‘punchbowl’ is going to be taken away; you have been warned.
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