What Is Tapering?

Tapering is a financial term that refers to the reduction of a central bank’s activities.
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What Is Tapering|what-is-tapering
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Tapering is a financial term that refers to the gradual reduction of a central bank’s activities.

A central bank will start tapering when they believe that the economy no longer requires excessive stimulus.

Primary changes to a central banks activities would be quantitative easing, adjusting the discount rate or reserve  requirements.

The central bank must get the rate of tapering at the correct balance.

Tapering too early could lead to recession and to late could lead to high inflation.

When Is Tapering Used?

During times of poor economic conditions such as the 2007 financial crisis a central bank will implement a stimulus monetary policy.

A central bank will introduce such measures as quantitative easing with the aim to improve the

Once economic conditions such as inflation and unemployment start to improve a central bank will then start to taper.

Each central bank will have their own targets of when to start tapering depending on how well each economy has been improving.

2018 has seen major central banks such as the Federal Reserve, European Central Bank and Bank of Japan all considering tapering.

How Is Tapering Used

Central banks will typically initiate a gradual taper rather than an abrupt halt to loosen monetary policies.

Once a central bank has decided to start tapering they will then outline their approach to the public in order to reduce market uncertainty.

By specifying in advance their plan to start tapering a central bank can allow the markets to adjust before actions are actually taken.

Areas effected by tapering would be:

  • Inflation and Deflation
  • Interest Rates
  • GDP
  • Employment
  • Asset Prices

For example:

A government is buying $90 billion worth of assets on a monthly basis.

They then reduce the asset purchases from $90 billion to $70 billion the following month.

This would be quantitative easing (QE) tapering.

What Can Go Wrong?

As mentioned before a central bank needs to taper at a gradual pace to keep a correct balance.

To taper prematurely or too rapidly could lead to a negative impact on the economy and can even lead back to recession.

Another thing that can happen is a “Taper Tantrum”, this is term used for when investors panics to reactions to news of tapering.

The term started being used for the surge in U.S. Treasury yields that occurred in 2013.

 

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