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Economy in Brief

Fed Chair Powell's Taper Talk Is Much Ado About Nothing
by Paul L. Kasriel  August 27, 2021

Fed Chairman Powell's taper talk at the 2021 Jackson Hole virtual barbecue is really about a "sterilized" taper, i.e., a taper without an increase in the fed funds rate. Powell indicated that the Fed would begin to reduce its outright purchases of securities by the end of this year. But, this tapering in outright securities purchases will not imply an increase in the Fed's target of the fed funds rate, according to Powell. A taper without an increase in fed funds rate can only be accomplished by the Fed replacing the reserves it drains via the cutback in outright securities purchases with reserve injections via temporary purchases of securities, or repurchase agreements. Outright Fed purchases of securities of $X vs. the continued rolling over of Fed repurchase agreements of $X is a distinction without a difference. In both cases the Fed has purchased $X of securities and, all else the same, has injected $X of reserves into the banking system.

The Fed has a monopoly on the supply of bank reserves. It can control either the supply of these reserves or the interbank borrowing interest rate on these reserves, the fed funds rate, but not both simultaneously. All else the same, if the Fed reduces its outright purchases of securities, the supply of reserves will fall. Unless, for some reason, the banking systems' demand for reserves should decline commensurately, the fed funds rate will rise. If the Fed did not want the fed funds rate to rise, it would have to offset the decline in reserves resulting from its cutback in outright purchases of securities by an increase in the temporary provision of reserves via repurchase agreements. Hence, a "sterilized" taper. So, a sterilized taper results in the same change in the Fed's holdings of securities, just that the change in its outright "permanent" holdings has declined and the change in its "temporary" holdings has increased. The change in total bank reserves has not changed. If the change in bank credit also has not changed, then a "sterilized" taper results in no change in thin-air credit. Thus, a "sterilized" taper is much ado about nothing. The bottom line is that the Fed intends to keep sowing the seeds of future higher sustained inflation despite its current plan to cut back on its outright purchases of securities sometime before year end. So, I hope Fed officials enjoy their barbecued meats now. They might not be able to afford them next year. Oh, I forgot, they can "print" the money to buy them, regardless of increased price.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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