Tapering

What is tapering?

Tapering is the gradual reversal of a central bank’s quantitative easing (QE) program. During QE, a central bank buys assets (like government bonds and mortgage-backed securities) to inject liquidity into the economy. Tapering slows and then stops those asset purchases, and may include allowing assets to mature or reducing the central bank’s balance sheet. It is a transitional step between expansionary policy and outright tightening.

Why central banks taper

• QE is intended to support recovery during downturns. Once recovery is underway, continuing large-scale asset purchases risks higher inflation and asset price bubbles.
• Tapering withdraws stimulus in a controlled way to avoid sudden shocks that could tip the economy back into recession.
• It helps normalize monetary policy while giving markets time to adjust before interest-rate increases or other contractionary measures.

How tapering affects financial markets

• Reduces demand for long-term bonds, which tends to push bond yields higher.
• Higher yields can lower equity valuations and increase borrowing costs for businesses and consumers.
• Announcements of tapering can cause sharp market reactions—often called a “taper tantrum”—if investors are surprised or if communication is unclear.
• Clear, forward guidance from central banks helps set expectations and reduce volatility.

Tapering vs. tightening

• Tapering: the reduction or end of asset purchases under QE; a gradual withdrawal of one form of stimulus.
• Tightening (contractionary policy): explicit steps to slow the economy, such as raising short-term interest rates and/or actively selling assets from the central bank’s balance sheet.
  Tapering is typically the bridge between QE and full tightening.

Notable examples

• Post‑2007–08 crisis: After large QE programs, central banks began tapering as conditions improved. A prominent example is the 2013 announcement that led to market volatility when the Fed signaled plans to reduce monthly asset purchases.
• COVID‑19 response: Central banks implemented aggressive QE in 2020. As economies recovered and inflation rose, policy shifted: asset purchases were tapered and, later, balance sheets were reduced while interest rates were tightened.

When does tapering begin?

Tapering usually begins once policymakers judge that QE has achieved its aims—stable recovery, improving employment, and manageable inflation. It is typically enacted gradually and communicated clearly to avoid destabilizing markets.

Key takeaways

• Tapering is the gradual winding down of quantitative easing and a reduction in central bank asset purchases.
• It aims to remove stimulus without disrupting growth, helping prevent inflation and asset bubbles.
• Markets often respond to tapering with higher bond yields and equity volatility; transparent communication by central banks reduces risk of sharp reactions.
• Tapering is distinct from tightening, which involves higher interest rates and active balance-sheet reduction.