Federal Reserve: Tapering of Asset Purchases

Federal Reserve: Tapering of Asset Purchases

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INSIGHTi

Federal Reserve: Tapering of Asset Purchases
Updated January 27, 2022
In November 2021, the Federal Reserve (Fed) announced that it would begin to “taper” its large-scale
asset purchases, popularly known as “quantitative easing” (QE), by $15 billion per month (see Table 1).
In light of the further increase in inflation, it announced in December that it would double the monthly
reduction in purchases in January. In January 2022, the Fed announced that purchases would end in
March, at which point its balance sheet will stop growing. Under tapering, the Fed will continue to
purchase Treasury securities and agency mortgage-backed securities in a two-to-one ratio.
Table 1. Fed Monthly Asset Purchases
(billions)
2021-2022
Amount
Decline from Previous Month
Before Tapering
$120
n/a
After November Tapering Announcement:

November
$105
$15
December
$90
$15
After December Tapering Announcement:

January
$60
$30
February
$30
$30
March
$0
$30
Source: CRS.
Tapering is the first step in the eventual “normalization” of monetary policy from the highly stimulative
policies in response to COVID-19, which included asset purchases. Tapering itself withdraws some
stimulus, and its pace determined when the Fed will begin raising interest rates. The Fed could have
raised the federal funds rate at any time but will wait until tapering has ended, consistent with past
practices. In January, the Fed announced “it will soon be appropriate to raise” rates. The Fed also stated
that it would begin to reduce the size of the balance sheet sometime after the federal funds rate had been
increased, primarily by not replacing maturing securities.
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History of Asset Purchases
QE was first used in three rounds between 2008 and 2012 in response to the financial crisis when the Fed
purchased Treasury securities, MBS, and agency debt. Tapering was first used in 2013 to wind down
QE3, and the surprise caused Treasury yields to rise and financial volatility in emerging markets
(popularly called the “taper tantrum”).
The Fed holds securities it buys as assets on its balance sheet and has financed its purchases by expanding
its liabilities by an equal amount. Securities held by the Fed increased from $0.8 trillion before the
financial crisis to $4.2 trillion by the end of 2014, as seen in Error! Reference source not found.. Bank
reserves held at the Fed are the primary liability that has increased over this period. While the Fed has not
literally “printed money” to finance these purchases, increasing bank reserves has a similar effect, as bank
reserves are part of the monetary base. Bank reserves have increased from $40 billion at the beginning of
2008 to $3.8 trillion at present.
Figure 1. Federal Reserve Balance Sheet

Source: Federal Reserve.
In the fall of 2019, a liquidity shortage caused repo market turmoil, prompting the Fed to begin
purchasing Treasuries again. Asset purchases rapidly increased in response to financial unrest caused by
the pandemic’s onset in the spring of 2020, with securities holdings increasing by about $2 trillion in two
months. MBS purchases resumed then, and for the first time the Fed purchased agency CMBS (MBS
backed by commercial mortgages) in relatively small amounts. Beginning in June 2020, the Fed
purchased $120 billion of securities per month—a faster rate than the rounds of QE following the
financial crisis. In December 2020, it pledged to continue purchases at this rate “until substantial further
progress has been made toward its maximum employment and price stability goals.” When tapering was
first announced, the unemployment rate had fallen from 6.7% to 4.8% and the Fed’s targeted inflation
measure had risen from 1.3% to 4.3%. Since March 2020, the Fed’s securities holdings have doubled to
$8.9 trillion.

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The Fed’s Rationales for QE
During every period of asset purchases except 2019 to March 2020, the federal funds rate (a short-term
interest rate that is the main target of monetary policy) was near zero. QE allowed the Fed to provide
additional stimulus when the economy faced deep recessions by reducing Treasury and mortgage rates
when short-term rates were constrained by the “zero lower bound.” A reduction in those rates would be
expected to feed through to other long-term rates throughout the financial system, thus boosting interest-
sensitive spending, which most studies have confirmed. In the pandemic, the Fed also emphasized the
effects of QE on reviving liquidity in stressed financial markets. Boosting overall bank reserves helps
ensure that individual banks maintain adequate liquidity. In addition, the financial crisis originated with a
crisis in mortgage markets and featured financial distress at Fannie Mae and Freddie Mac. Purchasing
agency debt and MBS helped relieve stress in mortgage markets more directly. By contrast, today housing
markets are generally booming.
Policy Implications of Tapering
Now that tapering has begun, how quickly should the Fed normalize monetary policy? Although QE
increases the monetary base, which can theoretically lead to higher inflation, this did not occur as some
critics feared after the financial crisis. Instead, inflation was generally below target before the pandemic.
However, inflation was well above the Fed’s target in 2021. In the Fed’s view, the rise in inflation does
not require policy to be tightened more quickly, given the economy has not yet returned to full
employment and the pandemic continues. Some critics would like the Fed to wait until the pandemic is
over to begin tapering. Others see little justification for continuing asset purchases—a tool intended for
crises—during a financial boom and high inflation and fear that the slow pace of tapering has put the Fed
behind the curve in maintaining price stability.
The Fed’s permanently larger balance sheet also raises broader policy issues: Is it appropriate for the Fed
to hold a significant share of the federal debt and MBS outstanding? Is it appropriate for the Fed to pay
banks interest on reserves and operating standing repo facilities in order to make interest rate control in
the presence of a large balance sheet possible? Because of the Fed’s independence, Congress does not
interfere with specific monetary policy decisions, and it is difficult to devise legislative constraints on
future asset purchases or the balance sheet that would not impinge on the Fed’s independence.
Furthermore, the Fed needs the authority to buy and hold some types of securities for normal monetary
operations outside of QE. Some past bills would have revoked its authority to purchase MBS or allowed
MBS purchases in crisis conditions only.

Author Information

Marc Labonte

Specialist in Macroeconomic Policy

Congressional Research Service
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Disclaimer
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