I have read some angst over the past two weeks regarding the “taper”. This refers to the reduction in the amount of assets purchased by the Federal Reserve each month. While the Fed is slowing the amount of monthly purchase, this should not be considered a tightening activity.
Let’s start with Federal Reserve policy. Typically the Fed increases or decreases an interest rate know as the Federal Funds rate to affect the economy and to counter the business cycle. In 2008, the Fed Funds rate had been decreased to the point where it was nearly zero and the economy was still struggling in a recession. The next option was to engage in a pattern of security purchases known as Quantitative Easing (QE). The first three QE programs were limited in size. The QE program we are currently in does not have a specified size or end date. I have summarized all of this in a new chart on the analytical road blogspot (opens in a new window). The Fed Funds rate is the line in red. Since this chart has a bit of history, it is easy to see where the rate was increased and decreased. The most recent decrease began in 2007 and ended at the zero bound in 2008. The green line is the size of the balance sheet of the Federal Reserve. As the QE programs have taken place, the size of the balance sheet has risen dramatically.
The point of this is the very far right of the balance sheet line. There is a slight turn in the upward movement. That is the effect of the “taper”. Notice, the line is still moving up which indicates that easing is still taking place. Once this line moves down or the red line begins moving up, then and only then can it be said that there is a tightening program taking place by the Fed.
When it comes to analytics, this analysis is very straightforward. I wish I would have kept the links to the news reports mentioning the Fed was beginning a tightening program since it would have been useful to include them here. Easing less is not the same as tightening.