Q&A: What is tapering?

us federal reserve The US Federal Reserve has expanded its balance sheet by trillions of dollars to fight the downturn

Since late 2012, the US central bank, the Federal Reserve (or simply the Fed), has been spending $85bn a month to boost the US economy.

That is the most recent phase of quantitative easing (QE), a policy that began as a response to the financial crisis that struck in 2007.

Under the plan, the Fed has been buying assets - a mixture of US government debt and mortgage bonds. This has the effect of driving down US interest rates, including the cost of mortgages, car loans and financing for business.

But on Wednesday, the Fed announced that it was scaling back - or tapering - that support to $75bn a month.

So what is tapering anyway?

It is a gradual phasing out of the Fed's bond-buying programme.

On Wednesday, we learnt that tapering is starting in January, when the Fed will reduce purchases of mortgage bonds and Treasury bonds (US government debt) by $5bn each.

That means it will buy $35bn in mortgage bonds each month and $40bn in Treasuries.

Some say it is a small, symbolic move.

"A $10bn change won't be missed. It won't impact the economy. A change this small is almost like it had done nothing at all," said Todd Schoenberger, managing partner at Landcolt Capital.

The Fed also softened the blow, though, by saying that its benchmark short-term interest rate would remain close to zero until unemployment was "well past" 6.5%.

Further tapering will depend on how the economy responds.

Why now?

The timing surprised some analysts, who thought the Fed might wait until next year to cut back its support.

Fed Chairman Ben Bernanke said he consulted closely with Fed Vice-Chair Janet Yellen on the decision.

Ms Yellen is due to succeed him when he steps down on 31 January after eight years in charge.

The decision to taper indicates that both are confident that the US economic recovery is well entrenched.

The latest data seems to support that. Economic growth picked up to an annual pace of 3.6% in the third quarter, surprising many observers.

Unemployment fell to a five-year low of 7% in November.

Some are not convinced, though. Steven Ricchiuto, chief economist at Mizuho in New York, was not expecting the Fed to make its move until next March.

"I am afraid that taking the punch bowl away before the party has a buzz will prove to be a mistake," he said.

How much has the Fed committed to QE?

The Fed has taken on much more government and mortgage-backed debt, that now sits on its balance sheet.

That balance sheet, which records the assets held by the central bank, has expanded dramatically.

Since the recession, it has increased from about $1 trillion before the crisis hit in 2007 to close to $4tn, and that is likely to expand further.

The majority of that expansion is due to the purchases made under QE.

To put those figures in context, the combined value of the three biggest US technology companies - Apple, Google and Microsoft - is a little over $1tn and the total value of the UK economy in 2013 was $2.4tn.

Unless there is a collapse in confidence in US government finances or the dollar, the extra debt owned by the Fed should not be a problem.

That is a lot of money. Did it work?

By buying mainly US government bonds and mortgage-backed debt, the Fed kept interest rates low - particularly those that matter most to US consumers, such as those for mortgages and car loans. Sales of new homes, as well as the rate of refinances, and car purchases all picked up in the wake of QE.

Low rates also succeeded in pushing investors to the stock market, away from bonds, whose low interest rates were even less than inflation. This has led to the strong returns in US markets, with the S&P 500 index on track for its best year since 1998.

The Fed itself said in March that the asset purchase programme had had a "meaningful" effect in easing financial conditions.

It estimates that the policy has boosted employment in the private sector by two million.

Were there any unintended consequences?

The Fed's main goal was to keep interest rates low in the US and boost economic activity at home.

But the policy encouraged investors to look overseas for assets that promised a better rate of return than US government debt.

Some of those funds are now returning home. In fact, volatility on emerging markets in 2013 has been blamed on the threat of tapering.

In June 2013, when Mr Bernanke made comments hinting that the taper was near, stock markets plunged, mortgage rates spiked and the rate of refinancing activity plummeted.

When the expected taper did not come in September 2013, many accused Mr Bernanke and his fellow central bankers of bungling the communications and capitulating to markets, who continue to want low interest rates.

More on This Story

US Economy

Related Stories

The BBC is not responsible for the content of external Internet sites

More Business stories

RSS

Business Live

  1.  
    10:45: Club Med takeover battle
    ClubMed advert

    The stakes have been raised in the game to buy French holiday group Club Med. China's Fosun has raised its offer to €24.60 per share, which values Club Med at €939m. It trumps an offer from Global Resorts, which is controlled by Italian businessman Andrea Bonomi. His bid valued Club Med at €915m. Fosun wants to expand the firm in China and Brazil.

     
  2.  
    Via Twitter Douglas Fraser Business and economy editor, Scotland

    "Standard Life Investm'ts expands to new-build on sth St Andrew Sq Edinburgh: 10 new offices from Tokyo to Stockholm, expanding existing ones"

     
  3.  
    10:26: Air France shares slump
    Striking Air France pilots

    Shares in Air-France KLM have slumped 6% after the airline issued its third profit warning of the year late on Thursday. It blamed continued costs from a strike by pilots earlier this year. Sales, particularly of long-haul tickets, are weak, according to the airline. It also said that it was not yet seeing the benefit of falling oil prices.

     
  4.  
    10:13: Russia crisis
    A board showing currency exchange rates

    The Russian rouble has steadied gaining almost 3% and at one point it traded below 60 to the dollar. It comes after Russian finance minister Anton Siluanov said the rouble would definitely hold firm at the beginning of next year. He also said the ministry had been selling foreign currency.

     
  5.  
    10:00: Government borrowing falls

    Borrowing was also revised down for the first half of the year. Overall, year-to-date borrowing was £2.4bn less than first thought, mostly reflecting lower estimates of central government spending and higher assessments of receipts. The borrowing figure for November also came in £1bn less than the City expected.

     
  6.  
    09:49: Oil prices
    Brent crude price

    Oil prices have strengthened a bit this morning. North Sea Brent Crude is up 1% at $59.87 a barrel. You can see what a volatile week it has been from the chart above, with oil trading in a near $5 range and this week and breaking well below the $60 a barrel mark.

     
  7.  
    09:37: Government borrowing falls

    Government borrowing in November was £14.1bn, that's down £1.6bn compared with a year earlier, the Office for National Statistics (ONS) says.

     
  8.  
    Government borrowing falls 09:33: Breaking News

    Public sector borrowing from April to November 2014 was £75.8bn, a fall of £0.5 billion compared with the same period in a year earlier, official figures show.

     
  9.  
    09:20: Market update

    The FTSE 100 is stronger in early trading following that big jump for US shares on Thursday. Oil services firms have been hit this morning, Petrofac leads the FTSE 100 lower with a 4.5% loss.

     
  10.  
    09:02: Cyprus denied bailout cash

    The Cypriot parliament says it wants more time to draft a new law to protect people from losing their homes as a result of last year's banking crisis. The IMF says it will discuss the next steps with Cypriot authorities. The European Union had released a €350m instalment before the vote, bringing the amount of bailout cash given to Cyprus so far to €5.7bn.

     
  11.  
    Via Twitter Douglas Fraser Business and economy editor, Scotland

    "Big contract win for Schlumberger, providing drilling + well services for Statoil, in big new Mariner heavy oilfield, east of Shetland"

     
  12.  
    08:45: Cyprus denied bailout cash
    A  man walk outside a branch of Bank of Cyprus in Nicosia

    Remember last year's bank crisis in Cyprus? Well, the island nation may be in trouble again. The International Monetary Fund (IMF) is refusing to give Cyprus an €86m tranche of rescue money after the Cypriot parliament voted to suspend an insolvency law - due to take effect at the end of the month - that would have made it easier for banks to start to collect on bad loans.

     
  13.  
    08:40: North sea oil outlook BBC Breakfast
    Dominic Laurie, BBC Breakfast

    Around 375,000 people work in the UK oil industry and half of those are in north east Scotland says a cold looking Dominic Laurie from Aberdeen docks on BBC Breakfast. He speaks to the chief executive of Wood Group Bob Keiller. He says the industry has been through this kind of challenge before when the oil price collapsed in 1986 and 1998. He says the oil industry came out stronger.

     
  14.  
    08:25: North Sea oil outlook Radio 5 live

    More from Sir Ian Wood. He thinks that oil prices will be around $60 to $65 a barrel over the next 18 months and then will recover. That could prompt job losses of up to 10% in the UK oil industry, although he thinks it is more likely to be 5%. He says that investment plans are made 2-3 years in advance, so the impact is not immediate.

     
  15.  
    08:18: North Sea oil outlook Radio 5 live

    "Well over the top and far too dramatic," is how Sir Ian Wood describes a warning that the North Sea oil exploration business is close to collapse. Sir Ian is the Scottish billionaire who was commissioned by the government to carry out a review of the UK's oil industry.

     
  16.  
    08:09: Newspaper review
    Business pages

    The bid by IAG for Aer Lingus dominates today's business pages. Times Chief Business Commentator, Alistair Osborne says IAG's timing is not great as Aer Lingus shares are up 54% over the past year. Away from that, in the Financial Times Gillian Tett warns about the amount of dollar-denominated debt held offshore by companies from emerging markets. Graham Ruddick of the Telegraph warns that next year could be even worse than this year for the big supermarkets chains.

     
  17.  
    07:59: North Sea oil outlook BBC Radio 4

    Ian Theophilus an oil and gas consultant tells Today he expects a number of North Sea oil projects - planned with a higher oil price in mind - may be reduced or cut altogether. He says he is very worried about the prospect for North Sea oil in 2015. He says he and colleagues "remember the late 1980s and 1990s" when the oil price was between $9 and $11 per barrel and "everything was stuck". "The chances are that could happen again," he adds.

     
  18.  
    07:51: Keeping the lights on

    Reacting to the completion of the energy auction Energy Secretary Ed Davey, said: "This is fantastic news for bill-payers and businesses. We are guaranteeing security at the lowest cost for consumers. We've done this by ensuring that we get the best out of our existing power stations and unlocking new investment in flexible plant."

     
  19.  
    07:41: Keeping the lights on

    Companies will be paid £19.40 per kilowatt by the government to provide backup power following an auction process that has been going on all week. The new scheme is designed to ensure the nation has a sufficient energy buffer to cope with peak demand - usually over the winter.

     
  20.  
    07:32: Premier League TV review
    Premier League logo on a football

    Ofcom has launched a consultation on its view that the current division of Premier League and Champions League football between Sky and BT harms competition between pay TV retailers. Back in 2010 Ofcom ordered Sky to offer its sports channels to rivals at a price set by the regulator. It is now reviewing whether that has helped competition and "remains appropriate". There will be a second phase of the review in 2015.

     
  21.  
    07:20: North Sea oil outlook Radio 5 live
    North Sea oil platform

    It's extremely difficult to tell if the North Sea oil business is heading into the same kind of crisis that it saw in 1986, says Aberdeen businessman Charles Skene on Radio 5 live. Kenny Anderson the boss of an Aberdeen construction firm remembers the "strife" caused in 1986 when oil fell to $36 per barrel. But predicting oil prices is an "impossible game" he points out.

     
  22.  
    07:10: Samsung shareholder payout

    Samsung Electronics is considering increasing its dividend payout this year by between 30% and 50% compared to 2013.

     
  23.  
    06:56: Nigerian currency crisis BBC Radio 4

    Phillip Walker of the Economist Intelligence Unit, tells Today the crisis facing Nigeria is far bigger than the one facing Russia. Nigeria's currency the naira has fallen 15% against the US dollar this year forcing the country's central bank to impose foreign currency trading controls. "Nigeria has a bigger population than Russia, its economy relies on oil exports more than Russia, so it's a big problem," Mr Walker says.

     
  24.  
    06:48: Gas prices BBC Radio 4

    Professor Green says energy suppliers have an eye on politics at the moment. He says Labour leader Ed Miliband's promise to freeze energy prices for 20 months if his party wins next year's election may mean suppliers will keep prices artificially high despite currently benefitting from lower gas costs.

     
  25.  
    06:34: Gas prices BBC Radio 4

    While falling oil prices have recently caught the attention of many, the cost of gas has also been coming down. That's because demand in Europe has been falling due to a relatively warm winter so far. Richard Green professor of sustainable energy business at Imperial College London tells Today we shouldn't expect lower energy bills are a result. That's because energy suppliers are selling us gas they bought at last year's prices.

     
  26.  
    06:32: Asian markets

    Asian stock markets have had a mixed session. They Nikkei 225 is up more than 2%. Hong Kong's Hang Seng is up 1.4%. Shares in Shanghai have fallen back after hitting a four-year high in early trading. The Shanghai composite is down 0.1%.

     
  27.  
    06:21: China recalculates growth
    Chinese flag

    China's economy is bigger than originally thought. The government has revised up the size of the economy in 2013 by 3.4% to 58.8 trillion yuan ($9.5 trillion). The increase was mainly accounted for by a greater contribution from the services sector. In comparison, the US economy was worth almost $17 trillion in 2013.

     
  28.  
    06:14: IAG bid for Aer Lingus Radio 5 live
    Dublin Airport

    British Airways owner, IAG is "good at integrating new airlines" says Richard Hunter, head of equities at Hargreaves Lansdown. He is explaining why IAG made a bid for Aer Lingus. The Irish airline is attractive because it has lots of landing slots at Heathrow, says Mr Hunter. IAG may also have a bit more spending power because of the lower oil price, he adds.

     
  29.  
    06:06: North Sea oil jobs Radio 5 live
    Oil worker

    North Sea oil companies are cutting wages, rather than jobs at the moment, says Alan Savage chairman of recruitment company Orion Group on Radio 5 live. For agency workers wages have already been cut by up to 20%. He says that the British oil industry is highly taxed and the "government has a lot to answer for".

     
  30.  
    06:02: Russian crisis Radio 5 live
    Russian President, Vladimir Putin

    Next year is going to be grim for the Russian economy, says Craig Botham, emerging markets economist at Schroders on Radio 5 live. The economy is likely to contract 4.5%, inflation is forecast to be betweem 11% and 12%. The rouble could keep on weakening, "it's hard to see a particular floor for the currency" Mr Botham says.

     
  31.  
    05:59: Ben Morris Business Reporter

    Do get in touch. Email bizlivepage@bbc.co.uk or tweet @bbcbusiness.

     
  32.  
    05:59: Matthew West Business Reporter

    Morning folks. The news the US Federal Reserve is in no hurry to raise interest rates boosted shares on Wall Street and in Asia to new highs. Meanwhile the Bank of Japan maintained its commitment to government bond buying at its last meeting of the year. And we'll be keeping an eye on the Russia rouble and oil price again today and there may be more on IAG's bid for Aer Lingus. Stay with us.

     

Features

From BBC Capital

Programmes

  • An ECG (electrocardiogram)Click Watch

    The wearable technology which could allow you to pay for goods with your heartbeat

BBC © 2014 The BBC is not responsible for the content of external sites. Read more.

This page is best viewed in an up-to-date web browser with style sheets (CSS) enabled. While you will be able to view the content of this page in your current browser, you will not be able to get the full visual experience. Please consider upgrading your browser software or enabling style sheets (CSS) if you are able to do so.