The taper. Isn’t that a giant nocturnal pig? No, you’re probably thinking of the tapir. The taper is a kind of monetary policy. It’s the bland, one-word shorthand for the winding down of the biggest financial intervention in history: the U.S. Federal Reserve’s five-year investment of more than $3 trillion (that’s almost the size of the German economy) in bonds to prop up economic growth after the global free fall of 2008. There’s plenty of controversy about whether buying bonds with money conjured from thin air saved the world or has fueled new bubbles. But there’s been little about the perils the Fed faces in slowing the purchases down. To investors and central banks around the world, the taper is much scarier than pigs in the night.
Since December 2013, when the Fed’s policy-making committee announced that the time had come to taper, it has been making regular cuts to the bond-buying program known as quantitative easing, or QE. The Fed has pared its $85 billion in monthly purchases in seven straight reductions of $10 billion and plans to end it after a final $15 billion purchase in October. The end of the program started by Fed Chairman Ben S. Bernanke has been managed by his successor, Janet Yellen. There had been anxiety over how global markets would react, and in fact currencies and stock markets in emerging markets fell steeply in mid-January, as investors prepared for U.S. interest rates to rise. But markets rebounded, interest rates stayed low and the Fed stuck with its plan. Yellen has walked a fine line, assuring the markets that its benchmark interest rate would remain near zero for a “considerable time” after the taper’s end, and assuring Congress that more work needed to be done to boost U.S. employment. Instead of roiling global markets, the taper proved smooth enough to push volatility across equity, currency and bond markets to near-record lows.
The idea behind QE is that you don’t need a printing press to add money to an ailing economy. The Fed’s usual method of fighting recessions is to push down the interest rates banks charge each other for overnight loans, which allows banks to offer cheaper loans to businesses. But the Fed cut that rate almost to zero during the financial crisis five years ago, and more was clearly needed. So the Fed began buying bonds in hopes of driving down long-term rates that are usually outside its control. It wasn’t a new idea, but it had never been tried on such a massive scale. In the months after the crisis, the Fed bought $1.75 trillion in bonds. In 2010, with the recovery flagging, it bought $600 billion more in what was called QE2. In September 2012, with joblessness stubbornly high, the bank began snapping up $85 billion a month in Treasuries and mortgage-backed securities – QE3. Unlike earlier rounds, the Fed’s purchase plan was described as open-ended, with officials saying it would continue until the labor market “improved substantially.” The idea was that reducing the bond purchases gradually — that is, tapering them off — would make clear that the central bank would continue to offer support for the economy, just at lower levels. But it soon faced the problem of how to convince markets that a taper was different from an exit.
Almost since the first QE purchase, critics have been warning that it would spur inflation. They’ve been wrong so far. Price increases have remained consistently below the 2 percent the Fed regards as healthy. Others pointed to increases in the stock and housing markets as incipient bubbles fueled by the Fed. There’s also debate about how effective QE has been. Some economists see only a modest effect, coming mostly through lower mortgage rates. A former Fed official who executed the bond purchases, Andrew Huzar, charged that “while there had only been trivial relief for Main Street, the U.S. central bank’s bond purchases had been an absolute coup for Wall Street.” Yellen said that the pain for savers from low interest rates was more than offset by the help the policy has given to the labor market and the economy as a whole. At the same time, she acknowledged that QE “cannot continue forever.” But Fed officials have been at pains to convince investors that the end of the taper does not mean the end of stimulus. The near-zero interest rates they plan to leave in place until the labor market has recovered further would in ordinary times be seen as a massive stimulus; there just won’t be an extraordinary stimulus of massive bond purchases on top of it anymore.
The Reference Shelf
- A paper by the St. Louis Fed reviewing quantitative easing and the responses to the crisis of the Fed, the Bank of England, the European Central Bank and the Bank of Japan.
- The Fed explains how its monetary-policy committee works.
- The bank’s October 2013 policy statement.
- Josh Zumbrun’s Yellen profile in Bloomberg Markets Magazine.
- Yellen’s June 2012 “optimal control” speech backing QE and her Fed biography.
- Read UC Berkeley Economics Professor Brad DeLong’s presentation on Yellen.
- Ben Bernanke looks back on the Fed’s first 100 years and says how central banking has changed.
- Leading economists rethink post-crash macroeconomic policy at an IMF symposium.