After the financial crisis hit the world in 2008, the U.S. central bank, known as the Federal Reserve or the Fed, cut interest rates to abysmally low levels--practically 0%-- in a bid to stimulate the economy. But that was not sufficient.
So the Fed resorted to an unconventional monetary tool known as Quantitative Easing, or QE. This is the Fed’s programme of buying bonds—a mixture of government debt or U.S. Treasury notes and mortgage-backed bonds. In this way, cash is pumped into the system. From where does the Fed get the money? Like all central banks, it has the ability to simply create it. These asset purchases are done by the trading desk at the New York Federal Reserve Bank. This QE has been the largest economic stimulus programme in history and has spurred the economic recovery in the U.S.
However, it is not unique just to America. The U.K. too resorted to QE with the Bank of England embarking on a bond-buying programme. Last year Japan too sought to jump-start its economy by resorting to QE. The Bank of Japan's plan was to buy ¥7tn yen of government bonds each month with the aim of rekindling demand and pushing up prices and wages. The BoJ stated that it would continue on its aggressive bond buying programme till it achieves a 2% rate of consumer price inflation.
Tapering is simply the process by which the Fed is scaling back its purchases. From spending $85 billion on these purchases per month, it has been reduced to $75 billion. Tapering is not the end of the process, it’s just slowing down of its pace --a gradual phasing out of the bond-buying programme.
But will the Fed continue to wean the American economy off the fiscal stimulus? Will it stick by its decision to cut it back by a further $10 billion next month?
Will the U.S. tapering continue?
Last week the employment growth figures released were below expectations, which led many to wonder if the Fed may halt its tapering program.
However, Robert Johnson, Morningstar.com's director of economic research, does not believe that this data by itself will be enough to derail the Fed from continuing to taper its asset-purchase programme.
Johnson is highly suspect of this month's employment report and notes that the report was riddled with many big swings and inconsistencies. In addition, he pointed out several examples of data that were "nonsensical" in his mind. For example, 30,000 accountant jobs were lost in the month, 13,000 local school teachers lost their jobs midyear, and construction employment fell, which is in stark contrast to the massive gain in construction jobs as reported by payroll services company ADP.
As such, he is not putting much stock in this report and believes that a more realistic scenario would be to average the prior two months' reports together, as the 241,000 gain in the November employment report was probably higher than reality. That average in the low 150,000 area looks more reasonable to Johnson and is more consistent with the household survey data that showed 140,000 jobs added. He is sticking with his forecast for employment job growth to increase by an average 190,000 per month in 2014.
Even if the tapering continues and the Fed reduces purchases by $10 billion per month, the programme will still last until September 2014. Over this time frame, the Fed will purchase another $330 billion of securities, taking its portfolio to more than $4.3 trillion.
Johnson’s views have appeared in detail on Morningstar’s U.S. and U.K. websites.