Tapering

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DEFINITION of 'Tapering'

A gradual winding down of central bank activities used to improve the conditions for economic growth. Tapering activities is primarily aimed at interest rates and investor expectations of what those rates will be in the future. These can include conventional central bank activities, such as adjusting the discount rate or reserve requirements, or more unconventional ones, such as quantitative easing (QE).

BREAKING DOWN 'Tapering'

Central banks can employ a variety of policies to improve growth, and they must balance short-term improvements in the economy with longer-term market expectations. If the central bank tapers its activities too quickly, it may send the economy into a recession. If it does not taper its activities, it may lead to high inflation.

Tapering is best known in the context of the Federal Reserve's quantitative easing program. In reaction to the 2007 financial crisis, the Federal Reserve began to purchase assets with long maturities to lower long-term interest rates. This activity was undertaken to entice financial institutions to lend money, and it began when the Federal Reserve purchased mortgage-backed securities. In 2013, Ben Bernanke commented that the Federal Reserve would lower the amount of assets purchased by the Fed each month if economic conditions, such as inflation and unemployment, were favorable.

Being open with investors regarding future bank activities helps set market expectations. This is why central banks typically employ a gradual taper rather than an abrupt halt to loosen monetary policies. Central banks reduce market uncertainty by outlining their approach to tapering, and under what conditions that tapering will either continue or discontinue.

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