Quantitative Easing Tapering - Meaning & Its Importance

What Does Quantitative Easing (QE) Tapering Mean ?

Quantitative easing (QE) means increasing the money supply of the system. This is done when the Central Bank creates new money and uses the money to make asset purchases. These asset purchases inject the new money into the system.

Quantitative easing (QE) tapering is the reverse policy of quantitative easing (QE). It is when the government stops following the policy of quantitative easing (QE) gradually. For instance, at the present moment, the US government is buying $85 billion worth assets on a monthly basis. If the US government were to drop the asset purchases from $85 billion to $60 billion the next month, that would amount to quantitative easing (QE) tapering.

The Fed has been contemplating quantitative easing (QE) tapering for all of 2014. However, even the slightest mention of quantitative easing (QE) tapering sends the markets crashing. It is for this reason that the Fed is holding on and trying to find a better way and time to deal with the situation.

Why is Quantitative Easing (QE) Tapering Important ?

The policy of quantitative easing (QE) tapering has been talked about almost every day in the American media and the rest of the world. This is because it is the most important and the most unheard of monetary policy of our times. The magnitude of this policy is what provides it with this much importance. The way this policy’s implications unravel will have a long lasting and profound impact on various economic parameters. The summary of this has been provided in this article.

  • Interest Rates: The first and foremost impact of quantitative easing (QE) tapering will be seen on interest rates. The impact is almost immediate. In fact quantitative easing (QE) is generally used when the interest rates are already at zero level and yet the Central Bank wants to provide even more stimulus.

    Hence quantitative easing (QE) can be thought of as a sub-zero interest rate policy. The quantitative easing (QE) policy therefore lowers the interest rate when introduces. At the present moment, it has been present in the market for the past 5 years and the market has grown used to it.

    Hence, when the policy of quantitative easing (QE) tapering is adopted, it is expected to send the interest rates shooting. This is because a limited money supply means lenders will have to ration their lending. They will lend out money to those who can offer the highest interest rates and this competition will send the interest rates skyrocketing.

  • Inflation and Deflation: The policy of quantitative easing (QE) is inflationary. This is because it simply increases the monetary base in the economy. Therefore, when there is more money available and it is chasing relatively fewer goods, inflation occurs and prices skyrocket.

    The United States has undergone three rounds of massive quantitative easing (QE) and the prices there are grossly inflated compared to what they would have been without the quantitative easing (QE) policy.

    Hence, when the opposite policy of quantitative easing (QE) tapering is implemented, the inflation is likely to turn into deflation. This is because quantitative easing (QE) tapering pulls money out of the system. Hence there is now less money (as compared to before) chasing the goods available, making every good less expensive.

  • Employment: As we already know that employment is closely linked to that state of inflation or deflation in the economy. When there is excess money in the economy, the confidence is upbeat, more and more goods are being produced. Therefore, as a result, more and more people get employed in the economy. Therefore quantitative easing (QE) is positively correlated to a higher employment level.

    On the contrary, when there is less money in the economy, consumer confidence is low, people are making fewer purchases, and hence producers are producing fewer goods. Thus a lower money supply results in a downfall in employment levels. Therefore, a policy of quantitative easing (QE) tapering results in lower employment.

  • GDP: The amount of goods produced within an economy adds up to be its Gross Domestic Product (GDP). There is therefore a clear correlation between the amount of money supply in the system and the Gross Domestic Product (GDP). When quantitative easing (QE) is set into motion, the GDP of an economy goes up and the economy reaches the boom phase in the economic cycle. On the contrary when the policy of quantitative easing (QE) tapering is set into motion, the GDP of an economy goes down and pushes the economy into a recession.

  • Asset Prices: The money supply of any economy is linked to its asset prices. As the money supply increases, everybody in the economy has more purchasing power and asset prices tend to go up. However, when money supply decreases, the reverse happens and asset prices tend to deflate.

    In case of quantitative easing (QE) tapering, this is exactly what is expected to happen. The Fed has artificially inflated the dollar money supply by creating money and buying assets from the market.

    Currently, this is an ongoing policy and when the Fed decides to stop doing this, the money supply will fall causing the asset markets to contract. This will lead to an immense transfer of wealth in the population as everybody is invested in these markets to different degrees.

Quantitative easing (QE) tapering therefore is expected to have a huge impact on all the markets in the world. Since there is not much historical precedent, people are awaiting to see the end result of the use of this policy.

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