No Taper Tantrum & Other Recent Federal Reserve News, Explained
A still image from the July 2021 FRONTLINE documentary "The Power of the Fed."
Changes are afoot at the Federal Reserve.
On Nov. 3, Fed Chair Jerome Powell announced a widely anticipated slowdown to the asset-purchasing spree the Fed had launched in March 2020, in response to COVID-19. Just a few days later, also as expected, board member Randal Quarles said he would leave the Fed by the end of December. Both of those lobs followed the Oct. 21 announcement that the Fed was updating its ethics rules.
To make sense of it all, here’s a closer look at recent news.
What’s going on with Fed monetary policy?
Powell, chair of the U.S. Federal Reserve’s Board of Governors, confirmed Nov. 3 that the Fed would begin reducing the latest round of asset buying it launched last year, in an effort to stave off a pandemic-induced economic downturn. The main U.S. stock indexes — S&P 500, Dow Jones and Nasdaq — all rose to record levels after Powell’s statement.
Experts told FRONTLINE that the market’s stability following the announcement was largely due to clear communication from the Fed.
“I wasn’t surprised,” said Julia Coronado, president and founder of the economic research consulting firm MacroPolicy Perspectives. “What they announced … was very much in line with expectations.”
The asset-purchasing strategy — known as quantitative easing, or QE — has been credited with avoiding a COVID-19-induced economic crash, but, as examined in the July 2021 FRONTLINE documentary The Power of the Fed, some experts questioned why it was still continuing a year and a half later.
According to the Fed’s Nov. 3 announcement, it won’t stop the purchases immediately but will begin slowing the pace of its buying. As of October, the Fed was acquiring $80 billion of Treasury securities and $40 billion of mortgage-backed securities every month. In November, it will reduce purchases by $15 billion per month, to $70 billion in Treasury securities and $35 billion in mortgage-backed securities.
Barring significant changes, the reductions will continue on pace until the Fed reaches $0 purchases in June 2022. (Update: The Fed announced a sped-up timeline on Dec. 15.)
Why did the Fed wait so long to start tapering?
COVID-19 wasn’t the first time the Fed turned to buying up bonds in order to pump cash into the economy.
The Fed originally introduced the strategy in the wake of the 2008 financial crisis — and then kept the QE flowing. In 2013, when then-Fed chair Ben Bernanke announced a reduction, or “tapering,” the market reacted swiftly and negatively, leading Bernanke to retract the plan.
“Markets are like little kids,” Mohamed A. El-Erian, chief economic advisor at Allianz, told FRONTLINE in The Power of the Fed. “They want candy, and the minute you try to take the candy away, they have a tantrum.”
Eventually, Bernanke’s successor as Fed chair, Janet Yellen, was able to end that earlier QE experiment without a tantrum in 2014, in part by promising to maintain the massive balance sheet of assets the Fed had bought and to keep short-term interest rates low.
“Chair Powell learned the lesson that Ben Bernanke left behind in 2013, with the taper tantrum,” said Kaleb Nygaard, a senior research associate at the Yale Program on Financial Stability.
Why wasn’t there a taper tantrum this time?
Nygaard and others told FRONTLINE it helped that the Fed had been signaling its plans for some time prior to the Nov. 3 announcement. At its September meeting, the Federal Open Market Committee (FOMC) — the branch of the Fed responsible for setting U.S. monetary policy, primarily by raising or lowering interest rates and deciding when to buy bonds — laid out the possible reductions in detail.
Coronado said the Fed’s planned retreat pleased the market, which rewards predictability. “[Powell] was sort of signaling that he really wants to give the economy time to recover,” she said. “Markets like that.”
In his November statement, Powell also said the Fed would keep interest rates where they are, at 0.15%.
“When Bernanke started talking about tapering, everybody thought that meant he was ready to raise interest rates,” said David Wessel, head of the Brookings Institute’s Hutchins Center on Fiscal and Monetary Policy. “The Fed, this time, has been very careful to say we’re not going to raise interest rates until we’re done with tapering.”
On Nov. 3, Powell acknowledged the downside to low interest rates, which can increase employment and make it cheaper to borrow money but can also increase inflation — a burden borne disproportionately by low-income Americans.
“We understand the difficulties that high inflation poses for individuals and families, particularly those with limited means to absorb higher prices for essentials, such as food and transportation,” he said.
“We will use our tools over time to be sure it doesn’t become a permanent feature of life.”
On Nov. 10, the AP reported that U.S. consumer prices rose 6.2% in the past year, with inflation at its highest point since 1990.
“It’s obvious that we have a lot of inflation,” Wessel said but added that it’s too soon to tell what the full impact will be on lower-income Americans.
Could the Fed’s plan change?
The Fed could still adjust its tapering plan, Powell said at the press conference, emphasizing the unpredictability of the Delta variant. (Update: The Fed announced a sped-up timeline on Dec. 15.)
Benjamin Friedman, a professor of economics at Harvard University, said that a sudden resurgence of COVID cases could cause the Fed “to cut back and taper less rapidly or not at all.”
For now, the Fed’s financial holdings continue to grow, though at a slower pace. The Fed’s balance sheet more than doubled from $4.1 trillion in February 2020, before the Fed launched its QE experiment, to $8.5 trillion near the end of last month.
Karen Petrou, a financial and policy analyst and author of the 2021 book Engine of Inequality: The Fed and the Future of Wealth in America, said the Fed’s portfolio is currently so large, it equals at least one-third of the U.S. GDP.
She told FRONTLINE she saw the size of Fed’s portfolio as problematic: “It’s very dangerous for market functioning and, as a result, for economic inequality.”
And what’s up with Quarles?
Quarles — who, in addition to being a regular member of the Federal Reserve Board of Governors, also held the seat of Vice Chair for Supervision until that term ended last month and wasn’t renewed by President Joe Biden — submitted his resignation to the board on Nov. 8.
Quarles was appointed to both the Fed board and the vice chair seat by President Donald Trump in 2017. Since then, he has been criticized by Senator Elizabeth Warren (D-Mass.) and others for his role in setting the Fed’s regulatory agenda, a responsibility that includes promoting “the health of banks and the resilience of the financial system,” said Kathryn Judge, Harvey J. Goldschmid Professor of Law at Columbia Law School.
Quarles’ resignation followed those of two Reserve Bank presidents who quit amid recent scrutiny of market transactions by Fed officials.
OK, but what does Quarles quitting mean?
Experts told FRONTLINE Biden now has the chance to reshape the Fed, between appointing Quarles’ replacement and that of another outgoing vice chair, Richard Clarida, and deciding whether or not to renominate Powell, whose current term as Fed chair ends in February.
(Update: In a Nov. 22 statement, President Joe Biden announced he would renominate Powell for another four-year term as chair of the Federal Reserve Board of Governors. Biden also said he would nominate current governor Lael Brainard as vice chair. In the wake of Quarles submitting his resignation, that leaves three vacant seats on the board for Biden to fill.)
Read More: Who Is on the Federal Reserve Board?
“I think that does put President Biden in a situation of having both the opportunity but, really, an obligation, in terms of protecting the health of the economy, to act quickly” in making appointments, Judge said, underscoring the importance of candidates who would “further promote transparency and accountability, which has been a greater challenge than it ought to be for the Fed.”
“The biggest change that Biden can make at the Fed will come from the person who succeeds Quarles as vice chair for supervision,” said Wessel, of Brookings.
“The Biden appointees across the government … take a very different view of optimal regulatory policy than their Trump predecessors, and that will be true at the Fed, too.”
This story was last updated on Dec. 20, 2021, to reflect recent news.