A central bank’s monetary expansion policies, which were implemented to boost the economy, are modified through tapering. A country’s central bank may purchase asset-backed securities from its member banks as part of a quantitative easing program to pump cash into the economy and speed up recovery.
Once quantitative easing has stabilized the economy, tapering is started, which may involve adjusting the reserve requirements or discount rate. The Federal Reserve will decrease its asset holdings in the US as well.
When central banks implement an expansionary strategy to boost an economy during a downturn, they commit to undoing such strategies once the economy has recovered. Once a recession has ended, continuing to stimulate the economy with cheap credit can result in inflation and asset price bubbles that are driven by monetary policy.
The process of either slowing down or withdrawing from a monetary stimulus program that has already been implemented and judged successful begins with tapering. Setting expectations for the market and lowering market uncertainty are two benefits of being transparent with investors about the direction of central bank policy and upcoming initiatives.
In the case of quantitative easing, the central bank would declare its intentions to scale back asset purchases and let assets age or be sold off, therefore lowering the overall amount of assets held by the central bank and the money supply.
Due to “taper tantrums,” where investors and the financial markets overreact to a reduction in stimulus from the central bank, central banks may be hesitant to scale back their QE initiatives.
