Tapering and Quantitative Easing: Why the Terminology Can Be Confusing

Using English terms directly without translating them into our language can make their meanings unclear.

the Reader: Does the Federal Reserve offer catering services?  

Appt: Umm... yes? 🤔  

the Reader: I heard they’ve started catering.  

Appt: It’s not catering; it’s tapering.  

the Reader: Huh?  

Appt: Tapering refers to the process of reducing asset purchases…

Using English terms directly without translating them into our language can make their meanings unclear. However, it’s beneficial to understand what tapering means, as it significantly impacts the global economy and financial markets. Tapering usually appears when governments decide whether to stimulate the economy or control inflation.

To Understand Tapering, You Need to Understand Quantitative Easing

Appt: So, in order to break up, you need to be in a relationship first, right?  

the Reader: Where is this coming from?  

Appt: Tapering is the process of withdrawing money that was previously injected into the market. Thus, tapering presumes that money was injected in the first place, which is what we call quantitative easing.  

the Reader: Then why not use English for both terms or translate both into Korean?  

Appt: Tapering is known as ‘central bank asset purchase reduction program’ in Korean, and quantitative easing is translated as ‘quantitative easing’ in English…  

the Reader: Ah, got it. I’ll just memorize it!

Let’s start with an explanation of quantitative easing. When the economy is not performing well, central banks inject money into the market to stimulate growth. There are two main methods for this: lowering interest rates and implementing quantitative easing. 

1. Lowering Interest Rates

When the central bank lowers the benchmark interest rate, the interest rates for deposits and loans at banks also decrease. For businesses and individuals, lower deposit rates mean less incentive to save, while lower loan rates make borrowing cheaper. This encourages borrowing and investing in real estate or stocks, thus stimulating the market.

2. Quantitative Easing 

If lowering interest rates isn’t enough to revive the economy, central banks start quantitative easing. They print money and use it to buy bonds and other assets from the market. This increases the money supply, devalues the domestic currency (making it cheaper compared to foreign currencies), and enhances the competitiveness of export-oriented businesses. Quantitative easing was first used by the Federal Reserve during the 2008 global financial crisis as a drastic measure to boost the economy. Lowering interest rates alongside quantitative easing sends a message to borrow and spend money, increasing production and exports, often with minimal interest costs.

When Money is Injected, It’s Time to Reign It In

However, injecting too much money into the economy comes with side effects, primarily inflation. As people spend more due to the increased money supply, the prices of goods and assets rise, which can lead to inflation. This was evident during the pandemic, where financial markets overheated due to excessive liquidity. Inflation becomes more severe when political or economic events, like global supply chain disruptions or conflicts, occur, affecting the supply of goods.

Governments can’t ignore rising inflation. To curb it, they start withdrawing the money previously injected into the market. This is done through policies like raising interest rates or tapering (reducing asset purchases).

Tapering is essentially the reverse of quantitative easing. It involves reducing or stopping the purchase of financial assets such as bonds or mortgage-backed securities by the central bank. As cash flows into the market decrease, it can negatively impact the financial markets and potentially burst asset bubbles that were previously inflated.

What Context Does Tapering Appear In?

Revisiting the column on tapering in the Money Letter might clarify its meaning.  

🦩  

Given the current inflationary situation, the only solution is to reverse the previous measures. Tapering officially began in November 2021, eight months after inflation started to rise in March 2021. Subsequently, bond purchases through quantitative easing were ended. (Money Letter, August 6, 2024)  

Tapering signals the start of quantitative tightening, meaning that the high interest rate environment we’ve experienced post-pandemic is a result of tapering that began in 2022 and the subsequent interest rate hikes.