The Federal Reserve announced in its Federal Open Market Committee meeting Wednesday, Dec. 15, that it will begin tapering bond purchases in an attempt to curb rapid inflation. But what is bond tapering, exactly?
First, it’s helpful to consider the tools and resources the Fed has at its disposal to control inflation and other economic factors. First, to make a rapid economic impact, the Fed can raise interest rates. This, in theory, curbs spending, taking money out of the economy to slow inflation. The less money there is available, the greater the value each dollar has. The effect of raising interest rates can be almost immediate.
To make more gradual changes, the Fed can increase or decrease the amount of Treasury bonds it buys. Bond tapering means that the Fed reduces the number of bonds it purchases. Again, this reduces the amount of money in the economy. When the Fed buys Treasury bonds, the money they spend circulates as cash for the general public. When the Fed stops buying bonds, eventually the amount of cash in circulation will diminish. With less money in the economy, the value of each dollar grows. That means it takes fewer dollars to purchase goods and services; inflation slows.
When the Fed tapers, or slows, its bond purchases, there will be an increase in the number of bonds available on the market, resulting in lower bond prices. As a result, bonds may seem a more enticing purchase than stocks, which could lead to a dip in the stock market. Additionally, as inflation slows, stock prices may also drop as the value of each dollar increases. So far, however, the announcement had little effect on the Dow Jones Industrial Average and other major stock indices.
Plus, the bond tapering announcement hardly comes as a surprise. The Fed has said since early November that it would begin tapering bond purchases by the end of the year.
Right now, the Fed’s announcement to begin bond tapering probably won’t have immediate effects on U.S. consumers. Over time, it should help slow inflation, easing some of the financial burden on consumers whose salaries are not keeping pace with inflation.
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