We’ve been writing all day about how the Fed decided not to do something that market people call “The Taper.”
But my colleague Steve Kovach asks on Twitter what the heck that is, which is a good wakeup call that not everyone knows what we’re talking about when we refer to that.
So here’s your ultra-simple explanation of what’s going on….
In the middle of the 2008-2009 financial crisis, the Fed cut interest rates practically to 0% in a bid to stimulate the economy.
But even with these ultra-low rates, there’s still too much unemployment.
So how does the Fed keep stimulating if it can’t cut interest rates further?
The Fed buys a lot of long-term US Treasuries and Mortgage-backed securities to cut borrowing costs and pump cash into the system. The Fed buys these assets with money it creates out of thin air, which it can do because it’s the Fed.
At the moment, it spends $US85 billion on these purchases per month.
Tapering is the process of reducing the pace of these purchases to, say, $US75 billion per month. It’s not ending the purchases, it’s just slowing down the pace of new purchases.
Bernanke always said that the decision to “taper” would be dependent on the economy doing strongly.
But since the last two jobs reports weren’t that great, and Washington DC might shut down again, today the Fed decided to hold off, and perhaps start the taper at a later month.
End of story.