What is Tapering?

What is tapering? With the ECB we are once again talking about tapering, a choice of monetary policy that can be adopted by a central bank. With tapering we talk about stimulus and monetary policy and occurs when a bank wants to gradually decrease the stimulus to the economy.

What is tapering is the question that has come back into vogue on the markets in recent months, following the release of rumors that the ECB would be ready to implement a "tapering" of its monetary policy soon. Some, however, still remember the tapering inaugurated in the United States in 2013.

But what exactly is tapering, what does it mean and what monetary policy changes does it envisage?

What is tapering

The term tapering indicates a reduction of extraordinary measures of monetary policy implemented by central banks.

The first to explain the meaning of tapering was the American central bank, when in 2013 it began to reduce large-scale purchases of government bonds, the QE program, which began in 2008 with the subprime mortgage crisis.

From March 2022 the ECB started tapering, ending net bond purchases with Pepp and cutting bond purchases made with QE to 20 billion euros.

In other words, tapering is reduction in the pace of stock buying (known as quantitative easing).

The term tapering should not be confused with “tightening”, the English word that indicates a tightening of monetary policy conditions, typical of the periods in which an economy performs well and no longer needs stimulus from monetary policy.
The two terms should not be confused because they are not mutually exclusive. Tightening sees the Fed, for example, raise interest rates to control inflation.

Investors must, however, carefully evaluate the ECB tapering for the relative consequences on the euro and equity markets.

Tapering: the meaning explained

Tapering is the gradual reduction of the measures that central banks have introduced to improve the economy and to support growth. Tapering is mainly aimed at managing the interest rate and investor expectations on the future path of interest rates.

Central bank actions may include changes to conventional policies, such as adjusting the discount rate or reserve requirements, or to unconventional policies, such as quantitative easing (QE).

In the financial field, the term tapering was first used during the course of the Federal Reserve’s quantitative easing program. The program involved a large-scale stock purchase program with the goal of leading America out of the crisis.

As we know, central banks can use a variety of policies to enhance growth but they must balance short-term progress with long-term market expectations. If the central bank ends its stimulus measures too quickly, it can also push the economy into recession. But if the stimulus is slow to end, inflation rises above the hoped-for levels, as has happened in recent months, thanks to the war in Ukraine.

How tapering works: the case of the United States

In response to the 2008 financial crisis, the Federal Reserve began buying long-term assets to lower long-term interest rates. This was done to entice financial institutions to lend money to the public, and it began when the Federal Reserve bought mortgage-backed securities. In 2013, Ben Bernanke announced at a conference that the Federal Reserve would lower the amount of assets purchased each month if economic conditions, such as inflation and unemployment, remained favorable.

The tapering of the QE program in the United States, established in response to the 2008 financial crisis, began in 2013 and continued through most of 2014. In January 2014, the Federal Reserve announced plans to reduce the program from a monthly amount of $75 billion to $65 billion the following month. The cuts continued until the program ended in October 2014.

Subsequently, in mid-September 2019, the Fed injected new liquidity to lower Treasury yields, with a $60 billion monthly bond purchase program that was maintained until mid-2020.

The philosophy of tapering

Being open to investors about a central bank’s future intentions helps define market expectations. This is why central banks typically employ a gradual tapering rather than an abrupt halt to monetary stimulus.

The too-fast tapering implemented by the United States in 2013 had consequences on long-term bond markets, causing yields to soar and lower prices.

Central banks can reduce market uncertainty by outlining their approach and specifying the monetary policy path that must preserve the trend of corporate profits and contain inflation dynamics.