The word ‘taper’ has been on the lips of nearly everyone on Wall Street this year. After months of speculation, the Federal Reserve announced it does plan to taper its monthly asset purchases.
“It is time to taper, we think, because the economy has achieved substantial further progress toward our goals,” Federal Reserve Chairman Jerome Powell said in early November, indicating the process would begin this month.
Now that tapering is officially a go, what exactly does it mean and how does it affect consumers?
Definition
Taper (verb) is the gradual slowing down of central bank purchases of securities and bonds.
How we got here
When the economy is in deep trouble, like it is during a recession, the Federal Reserve starts buying up bonds to infuse more money into the financial system. This is called quantitative easing. It gives banks more money to work with, which encourages lending and investment, which stimulates the economy. It also helps push down interest rates, leading to 30-year mortgages being offered for under 3%.
When the pandemic sent shockwaves through the U.S. economy, the Federal Reserve initially bought more than a trillion dollars in Treasury securities and mortgage-backed bonds to calm the markets. By June 2020, the Fed settled into a rhythm of buying $120 billion worth each month. They’ve done that every month since.
“Our asset purchases have been a critical tool,” Powell said. “They helped preserve financial stability early in the pandemic.”
Time to taper
There’s danger associated with continuing this quantitive easing practice after the economy has recovered.
“When you pour in a lot of money into the economy and pour it in faster than the economy is growing, you can get inflation,” said economist Ed Yardeni, president of Yardeni Research.
Inflation in the U.S. is now at its highest level in three decades.
“They just announced that they’re going to taper and all that means is buy bonds at a slower pace,” Yardeni explained.
How it works
Starting in November, the Fed’s plan is to reduce, or taper, its monthly bond purchases by $15 billion each month until monthly purchases hit $0. So instead of $120 billion in bond purchases in November, the Fed will spend $105 billion. In December, that month’s purchases will drop to $90 billion, and so forth.
The Fed has signaled a slow drawdown because pulling the plug on economic stimulus too quickly can trigger what’s called a ‘taper tantrum.’ That’s when the market collectively panics at the thought of tapering. We first saw a taper tantrum in 2013 after the Great Recession.
“This time around, they’ve been signaling that they’re going to taper for so long that it’s like, ‘Okay, we accept it,’ and nobody’s having a tantrum about it,” Yardeni said.
How tapering affects consumers
So the usual market volatility hasn’t happened this time, at least not yet. But tapering has a couple of other effects that can affect consumers’ wallets. It tends to drive up long-term interest rates, which means mortgages and other loans become more expensive. On the plus side, tapering generally cools inflation, which means cost of living becomes more affordable.
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