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Tapering



Definition

Tapering, in the financial context, refers to the gradual reduction of central bank asset purchases, such as bonds or securities, that were implemented to stimulate economic growth. This process is typically done to ease the transition from an accommodative monetary policy back to normalcy, avoiding abrupt or excessive changes. It is often associated with a recovering economy and can influence market expectations and interest rates.

Phonetic

The phonetic pronunciation of the keyword “Tapering” is: /ˈteɪpərɪŋ/

Key Takeaways

  1. Definition: Tapering is a method used in sports, fitness, and exercise, which involves progressively reducing the volume and intensity of training before a major event or competition. It allows athletes to recover from fatigue, avoid overtraining, and maximize their performance during the main event.
  2. Purpose: The main goal of tapering is to help athletes reach their peak performance during competitions by carefully balancing rest and training stress. Tapering can lead to improved muscle strength, increased glycogen storage, enhanced aerobic capacity, and reduced risk of injury.
  3. Strategies: There are several approaches to tapering, such as linear, step, and exponential tapers. Each method involves reducing training volume, intensity, or frequency. The ideal tapering period and method vary depending on the athlete’s individual sport, fitness level, and training plan.

Importance

Tapering is an important business/finance term because it refers to the gradual reduction of monetary stimulus implemented by a central bank, directly impacting the economy and financial markets. As central banks purchase assets or reduce interest rates to stimulate economic growth during recessions, tapering is employed to ensure that the infusion of new money does not result in overheating or inflationary pressures. Investors and businesses closely monitor tapering decisions, as they can lead to fluctuations in asset prices, interest rates, and borrowing costs, ultimately affecting overall economic activity, market sentiment, and investment strategies.

Explanation

Tapering, in the context of finance and business, refers to the gradual reduction of monetary support provided by central banks in stimulating economic growth. This is achieved through cutting back on bond purchases and other assets, which have been implemented by the central bank to boost the economy during a period of financial distress or recession. The purpose of tapering is to prevent inflation from spiraling out of control and to maintain a stable economic environment as the economy moves towards a balanced state of growth. As an economy begins to recover and stabilizes, the central bank will utilize tapering to strike the right balance between stimulating economic growth and controlling inflation. The gradual reduction of asset purchases allows markets to adjust more seamlessly, preventing abrupt changes that could lead to financial disruptions. When executed properly, tapering effectively demonstrates the central bank’s confidence in an improving economy and provides a signal to the markets that it is appropriate to adjust financial activities accordingly. Overall, tapering ensures that the transition from recessionary support measures to normal economic activities is smooth and stable, ultimately leading to more sustainable growth for the economy as a whole.

Examples

Tapering, in a financial context, refers to the gradual reduction of monetary stimulus measures or asset purchases by central banks to tighten money supply and control inflation. Here are three real-world examples: 1. U.S. Federal Reserve’s Tapering in 2013: In May 2013, the then-chairman of the U.S. Federal Reserve, Ben Bernanke, indicated that the Fed intended to reduce its monthly asset purchases under its quantitative easing (QE) program. This tapering process, often referred to as the “taper tantrum,” aimed to gradually decrease the central bank’s bond-buying program from $85 billion per month. The announcement led to a spike in bond yields and a decline in global financial markets. 2. European Central Bank’s Tapering in 2018: The European Central Bank (ECB) announced in June 2018 that it would scale back its bond-buying program, signaling the end of its long-running asset purchase program. The ECB started tapering its net asset purchases from €30 billion per month to €15 billion per month until December 2018, with the intention of ceasing asset purchases thereafter. The move aimed to normalize European monetary policy after years of extraordinary stimulus. 3. Bank of Japan’s Stealth Tapering in 2017: Unlike the explicit tapering announcements made by the U.S. Federal Reserve and the ECB, the Bank of Japan (BoJ) engaged in a more discreet tapering process during 2017. The BoJ gradually slowed down its asset purchase program in an effort to control the expansion of its balance sheet and ease the pressure on its financial system, while avoiding a significant impact on global markets.

Frequently Asked Questions(FAQ)

What is tapering in finance and business terms?
Tapering refers to the gradual reduction in the pace of asset purchases by a central bank, typically implying a shift towards a less accommodative monetary policy. This process usually occurs when an economy shows signs of recovery, and the central bank believes it is time to manage inflation and avoid asset bubbles.
When and why do central banks initiate tapering?
Central banks initiate tapering when an economy is recovering from a downturn or financial crisis and exhibits sustainable growth. Tapering helps central banks curb inflation, stabilize the financial market, and maintain a healthy balance between asset prices and economic fundamentals.
How does tapering impact financial markets?
Tapering can impact financial markets in several ways, including:1. Increased volatility: As tapering signals a shift in monetary policy, it can create uncertainty in the markets, leading to increased volatility.2. Higher interest rates: The gradual reduction in asset purchases can lead to an increase in interest rates, making borrowing more expensive and affecting investment activities.3. Currency fluctuations: Tapering can cause currency values to fluctuate, with the domestic currency potentially strengthening against foreign currencies.4. Altered investor sentiment: Tapering may lead to cautious sentiment among investors, resulting in portfolio rebalancing and a redistribution of capital between various asset classes.
Can you provide an example of tapering?
One of the most notable examples of tapering occurred in the United States in December 2013 when the Federal Reserve began reducing the pace of its monthly bond purchases under the Quantitative Easing program. The program was aimed at stimulating the economy during the Great Recession. The tapering process continued until October 2014, resulting in a gradual reduction in the Fed’s monthly asset purchases from $85 billion to zero.
How can investors prepare for tapering?
Investors can prepare for tapering by:1. Monitoring economic indicators and central bank communications: Keeping an eye on key economic indicators and central bank announcements can help investors anticipate future policy changes.2. Diversifying their portfolio: Maintaining a well-diversified portfolio can help mitigate risks associated with interest rate fluctuations and market volatility.3. Considering fixed-income investments: With the potential for rising interest rates, investors may look to allocate funds to short-term fixed-income investments or bonds with shorter durations.4. Focusing on quality investments: During periods of tapering, it may be beneficial for investors to focus on fundamentally strong companies with robust cash flows and manageable debt levels.
Is tapering necessarily a bad thing for the economy?
No, tapering is not necessarily a bad thing for the economy. In fact, it indicates that the central bank believes the economy is strong enough to withstand reduced monetary support. Tapering may lead to short-term market fluctuations, but it is a necessary step for long-term stability and sustainable economic growth.

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