What is the Taper Tantrum?
The 2013 spike in U.S. Treasury rates that followed the Federal Reserve’s (Fed) statement that it would be tapering its quantitative easing program in the future is known as the “taper tantrum.” To inject less money into the economy, the Fed said it would be slowing down the rate at which it bought Treasury bonds. In the financial media, the subsequent increase in bond rates after the news was dubbed a “taper tantrum.”
Comprehending Taper Tantrum
The Federal Reserve implemented a strategy known as quantitative easing (Q.E.), which entails massive purchases of bonds and other assets in response to the 2008 financial crisis and the recession that followed. Theoretically, this boosts banking sector liquidity to preserve stability and encourage economic expansion. Encouraging lending helped stabilize the financial system, enabling consumer and company investment and spending.
Because of the risk that declining dollar values may trigger hyperinflation, quantitative easing—a monetary policy intended to increase the amount of money in the economy—has historically only been seen as a temporary solution. Conventional economists would argue that there are inevitable repercussions when the Federal Reserve supports the economy for an extended period. Theoretically, tapering—which would mean progressively lowering the amount of money the Fed injects into the economy—should help the economy become less dependent on that money and free the Fed from its role as its financial crutch.
But since 2015, the Fed has discovered several methods to inject money into the economy without depreciating the currency. The buyback window and other new policy instruments may have opened a new chapter in future research on macroeconomic policy. Still, it will take some time before scholars and economists are prepared to call such measures safe or harmful in retrospect. However, expectations for future economic performance and Fed policy are always factors in investor behavior and the existing state of affairs. Panic may still break out if the public learns that the Fed intends to start tapering because they fear that a shortage of money would lead to unstable markets. The more reliant on ongoing Fed backing the market has become, the more problematic this is.
Why Did the Taper Tantrum Occur in 2013?
2013 saw Federal Reserve Chair Ben Bernanke declare that the Fed would eventually scale down the number of bonds it bought. The Federal Reserve quadrupled the size of its balance sheet from around $1 trillion to over $3 trillion in the years after the 2008 financial crisis by acquiring almost $2 trillion in Treasury bonds and other financial assets to support the market. Investors had become reliant on the Fed’s continuous enormous asset price support due to its purchases.
Given that the Fed had grown to be one of the largest asset purchasers in the world, the proposed strategy of lowering the pace of asset purchases by the Fed offered a significant negative shock to market expectations. Bond prices would decline due to fewer Fed purchases, just as with any other decline in demand. Bond prices were instantly lowered because bond investors sold their bonds in response to the possibility of a future decrease in bond prices. Naturally, declining bond prices translate into higher yields, so U.S. Treasury rates skyrocketed.
Crucially, at this juncture, there had been no actual divestment of Fed assets or reduction in the Fed’s quantitative easing program. In his remarks, Chairman Bernanke only raised the prospect that the Fed may act in this manner in the future. The intense reaction bond markets showed at the time to the mere possibility of receiving less support in the future demonstrated the extent to which they had grown dependent on Fed assistance.
Given that it was well known that the Fed’s purchases of bonds were injecting money into the economy, many commentators thought that the stock market might do the same. If so, the economy may collapse due to the market’s response to the possibility of the Fed tapering. Instead, the mid-2013 Dow Jones Industrial Average (DJIA) falls were transitory.
Why Didn’t the Taper Tantrum Cause the Stock Market to Drop?
The stock market’s continuous health might be attributed to several factors. For starters, the Fed began a third round of enormous bond purchases in response to Chair Bernanke’s remarks, which resulted in an additional $1.5 trillion in asset purchases by 2015. Second, by encouraging investor confidence and aggressively controlling investor expectations via frequent policy pronouncements, the Fed demonstrated its strong belief in the market’s ability to rebound. The stock market steadied as investors recognized there was no need to worry.
Conclusion
- The term “taper tantrum” describes the collective reflexive panic that occurred in 2013 and caused a surge in rates on U.S. Treasury bonds when investors discovered that the Federal Reserve was gradually winding down its quantitative easing (Q.E.) program.
- The primary concern behind the taper tantrum was that the end of quantitative easing would cause the market to collapse.
- Ultimately, the market recovered once the tapering program started. Therefore, the taper tantrum’s fear was unjustified.
