What is the Fed taper? An economist explains how the Federal Reserve withdraws stimulus from the economy

The Fed started tapering its purchases in December 2021 and by the spring of 2021, the economy showed significant strength and a cost-of-living surge. As shown in the figure below, annual U.S. imports tariffed under Section 232 (as measured by prior-year values) have soared from nothing before Trump’s first term to nearly $150 billion. If the IEEPA tariffs are wholly or partially rolled back, Section 232 tariffs can be expected to rise commensurately.

Tapering is the central bank’s reduction or gradual scaling back of monetary policy stimulus or asset purchase program. It aims to decrease the pace of economic growth and prevent inflationary pressures. When a central bank employs this process, it reverses its ongoing quantitative easing programs. Too much economic stimulus from Fed policy could lead to excesses of borrowing, spending and inflation in the prices of goods, services and financial assets. It’s a balancing act—investors may cheer rising stock and bond markets in the short-term, but long-term investors should also appreciate sustainable growth without excessive imbalances. In the financial world, tapering is the gradual abandonment of a central bank’s quantitative easing program.

QE is seen as a signal from the Fed that it intends to keep interest rates low for some time. Overall, the large-scale asset purchases that took place during and after the global financial crisis had powerful effects on lowering 10-year Treasury yields. Normally, when a central bank wants to reduce the cost of borrowing for companies and consumers, it lowers its target short-term interest rate. But with its target rate at zero during the 2008 crisis – at the same time that there was no inflation and the economy was still hurting – the Fed was no longer able to cut rates further. And so the Fed turned to quantitative easing as a way to continue to reduce borrowing costs.

• The Federal Reserve System is the central banking system for the United States.
• Read Rebecca Patterson’s full assessment of how markets have fluctuated since Trump’s so-called Liberation Day.
• When the Fed began aggressively buying assets in 2020 to help soften the financial impact of the COVID-19 pandemic, it marked a pause in its tapering of asset purchases.
• Through its quantitative easing program, the Fed follows a defined schedule of purchasing a specified quantity of financial assets, such as bonds, from banks and other financial institutions.
• By tapering, the Fed is gradually reducing the amount of monetary stimulus.
• With QE, a central bank buys a large amount of assets from the market each month to jumpstart economic activity.

Process of Tapering

With QE, a central bank buys a large amount of assets from the market each month to jumpstart economic activity. Tapering refers to the Federal Reserve policy of unwinding the massive purchases of Treasury bonds and mortgage-backed securities it’s been making to shore up the economy during the pandemic. As a result, investors tend to like it when central banks add more QE, but aren’t so happy when they reduce it. Since it signals a shift toward tighter monetary policy, it usually is positive for the currency, since currencies often increase when short-term domestic rates rise.

The Panama Canal Concessions Came at a Cost

Let’s look at what the Federal Open Market Committee, or FOMC, the main monetary policymaking body of the Federal Reserve, may do when the how to trade bill williams fractals economy weakens. President Trump made Panama an early priority of his second administration, publicly mentioning the country and its canal fifteen times between December and May. The United States is near full employment, and restrictive immigration policies mean there are fewer workers waiting in the wings.

Tips for Investors

This process is usually perceived as a positive signal, reflecting confidence in the economy’s strength. It indicates that the economy can sustain itself with reduced monetary support. However, if the process is too abrupt, it may lead to market volatility and economic instability. Therefore, it requires careful planning, communication, and execution to maintain stability in financial markets and the economy. While independent economists are skeptical about these claims, Treasury Department data shows that tariff revenues are up substantially this year. As of July 1, roughly $97.3 billion in tariff revenues had come into the Treasury, up some 110 percent from the same period of 2024.

How Tapering Affects Financial Markets

As a result of the years-long stimulus, the Fed’s balance sheet increased from $862 billion in August 2007 to $4.52 trillion by January 2015. Tapering can impact debt markets and can have a ripple effect on U.S. and emerging market stocks. However, the extent of that impact can vary depending on whether the markets are expecting the taper or if it comes as a surprise. Then, in mid-September 2019, the Fed injected new liquidity to lower Treasury yields, with a program of purchasing 60 billion in securities per month that was maintained until mid-2020.

Tapering and the impact on the markets

A higher fed funds rate translates into higher consumer and business loan rates and slower economic expansion. If the economy continues to improve as the FOMC expects, then each month the pace of purchases could decline by similar dollar amounts. Assuming the recovery remains on track and the FOMC continues its monthly tapering pace, by mid-2022 the Fed will complete the taper and no longer be purchasing securities that increase the size of its balance sheet. At some point in the future, the FOMC will need to decide when to reduce the size of its securities holdings.

• You can see the expansion of the Fed’s holdings in the area chart below, which shows total securities holdings rising from $3.8 trillion in February 2020 to $8.0 trillion as of the end of October 2021.
• One should remain vigilant for opportunities in the housing market, and perhaps capitalize on the low-interest-rate environment while it is still available.
• By tapering asset purchases, the Fed may help reduce inflation – or at least slow its rise – because it is withdrawing some of the monetary stimulus that is fueling economic growth.
• That was followed by Operation Twist, where the Fed bought longer-term assets while selling shorter-term securities.

Companies are now looking to get more out of the factories and facilities they already have, upping the use of existing production lines and workforces. Meanwhile, the hundreds of billions of dollars in new foreign direct investments that companies have pledged will take years to materialize and could depend on the investment climate. One of the stated goals of Trump’s tariff policy is to bring manufacturing jobs back to the United States. The number of jobs in these sectors has fallen from seventeen million to thirteen million over the last thirty years, even as overall manufacturing output has grown. Just as the assault on Huawei lit a fire under innovation, renewed restrictions have made it easier for Party leaders to rally the nation against foreign humiliation.

You can see the expansion of the Fed’s holdings in the area chart below, which shows total securities holdings rising from $3.8 trillion in February 2020 to $8.0 trillion as of the end of October 2021. One of the benefits of tariffs touted by the Trump administration is that they will bring in substantial revenues to the U.S. White House senior counselor for trade Peter Navarro has claimed that the tariffs will generate as much as $6 trillion in revenues over the next decade. Tariffs make it more difficult to meet U.S. defense requirements in many of the same ways that they affect American households.

If the central bank concludes its stimulus measures too quickly, it can also push the economy into recession. But if it delays concluding the stimulus, inflation rises above the hoped-for levels, with the need to intervene as happened from mid-2022 onwards (with record interest rates). Tapering refers to the Federal Reserve practice of reducing the pace of its purchases of securities. Tapering is used as a tool to moderate economic growth and is often practiced when prices begin to rise faster than the Fed target of 2% annual inflation. In addition to tapering, the Fed uses interest rates to help manage the economy so that price hikes are moderate and jobs are plentiful. In December 2013, the Fed began to taper, reducing the pace of asset purchases from $85 billion per month to $75 billion per month.

Either way, we don’t try to forecast short-term market movements here at Wespath. We’ll maintain our disciplined, long-term investment philosophy, which has successfully weathered past periods of uncertainty and should position us well as the Fed moves through the tapering process. In other words, Fed Chair Jerome Powell and other Fed officials want to prepare investors for changes to policy without sparking short-term panic about stock and bond prices. Tapering is also a way for the central bank to raise interest rates slowly. To avoid this, the central bank will start to sell assets and raise interest rates.

Americans have enjoyed rock-bottom interest rates for the better part of the past 13 years, helping to make it cheaper to borrow money to buy cars and homes and start businesses. The Consumer Price Index, which includes several categories of everyday items that a typical American might buy, is the measure of inflation most often reported in the media. Growing concerns among economists that rising inflation could harm the economy are likely a big part of what led the Fed to begin tapering. “Substantial further progress” indicates progress made toward maximum employment and price stability, and is how the Fed gauges when to begin the taper. 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.

This is usually accompanied by a withdrawal of the emergency liquidity measures implemented during the crisis. That was followed by Operation Twist, where the Fed bought longer-term assets while selling shorter-term securities. The last leg of large-scale asset purchases lasted from September 2012 until 2014, totaling $790 billion in Treasury securities and $823 billion in agency MBS. Liftoff ordinarily occurs in stages, as the Fed lifts interest rates by a quarter of a percentage point or so at intervals of a month or two until the dual goals of stable prices and full employment are reached.

At his January press conference, Powell emphasized that the balance sheet reduction would only start after the Fed began raising rates, and that the federal funds rate would remain the Fed’s primary policy tool. He described the balance sheet shrinkage as a process that would be “running in the background” alongside the Fed’s rate hikes. Central banks attempt to gradually wean the financial system and the economy off the stimulus measures put in place during periods of economic weakness through tapering. Moreover, it is an essential tool for the central banks to manage the economy and maintain stability. However, it may lead to market volatility and economic instability if improperly executed.