Tapering
Candlefocus EditorTapering is an economic term used to describe the gradual reduction of central bank assets by a central bank, in order to reverse the quantitative easing policies that have been implemented to stimulate economic growth. Quantitative easing (QE) is a policy used by central banks when interest rates can no longer be reduced effectively to stimulate the economy.
In a QE policy, the central bank buys government bonds or other forms of assets from the private sector to increase the liquidity and money supply in the economy. This policy is typically pursued for an extended period of time, and tapering reverses this policy and reduces the amount of assets purchased by the central bank. Tapering is sometimes referred to as reverse quantitate easing, which implies a cautious approach that slowly reduces the amount of stimulus instead of abruptly stopping it.
The reduction of assets purchased by the central bank creates a tighter monetary policy, as the central bank is decreasing its own money supply, making it more difficult for households and businesses to access the money they need to borrow and spend, making it more difficult for businesses and households to borrow money.
Since the program of buying assets increases the amount of money in the economy, when it is reversed, the money supply reduces, making it harder for people and businesses to borrow money and stimulate economic growth. This decrease in liquidity can cause volatility in financial markets, leading to a decrease in stock prices, bond prices, and other assets. These decreases are known as the "taper tantrum".
Tapering is often used when there is an active concern of an overheating economy, where inflation is rising too quickly and economic growth is redlining. Tapering is intended to slow the money supply, reduce inflationary pressure, and help stop an economy from growing too quickly and entering a recession.
Tapering can also be used to control liquidity following a period of quantitative easing. The central bank needs to control the money supply to help avoid any damaging inflationary pressures or bubbles and to help keep economic growth sustainable. Through tapering, the central bank is able to gradually buy up fewer assets, both targeting and controlling inflation, and gradually reducing the amount of money in the economy, putting it back in line with economic growth.
In conclusion, tapering is a tool used by central banks to reduce the amounts of assets purchased in the market, leading to a tight monetary policy, and is done to help prevent unsustainable economic growth or rising inflation. Tapering is a calculated reversal of the quantitative easing policies that have been implemented to help stimulate economic growth, and can result in a market downturn, known as a "taper tantrum".