Man 1:- Do you know, they are saying there’s going to be a sequel of taper tantrum?
Man 2:- Yes after Raghuram Rajan announced, right?
Man 3:- Which movie are you guys talking about? Is taper tantrum a movie and Raghuram Rajan his director???
Are you like man 3 and not aware about this word “taper tantrum” then don’t worry we will help you. Just continue to read till the end.
To make you understand, let’s take you history. Once upon a time in 2008 the financial crisis went up in the US. The reason for such a crisis was the faulty policies of banks and low interest rates for issuing a loan. Because of low interest rates many people borrowed money but they were un-eligible to repay them. As time passed, more gambling began and risks also increased. Eventually it was the banks who suffered as they were left with unpaid loans. Many of the big banks who thought they had a lot in their hands when they found out the real situation were shaken. Also they were not far from being bankrupt.
So when everything was going on like a tragic movie, the Federal Reserve (Fed) came up with a policy of Quantitative Easing (QE). So now let’s understand this term Quantitative Easing in order to elucidate more:
Quantitative Easing (QE) is a form of monetary policy in which the central bank buys long-term securities from the open market to increase the flow of money (liquidity). It usually involves a country’s central bank purchasing longer-term government bonds, as well as other types of assets, such as mortgage-backed securities (MBS). Similar situation occurred due to COVID-19 pandemic. As there was an economic shutdown, on 15th March 2020, the U.S. federal Reserve announced a Quantitative Easing plan of over $700 billion. Then, on June 10, 2020, after a brief tapering effort, the Fed extended its program, committing to buy at least $80 billion a month in Treasuries and $40 billion in mortgage-backed securities, until further notice.
Now let’s come back to 2008, money could be pumped into the market in different ways. It might be by lowering the interest rate (Repo rate) which could be passed on by the banks, buying securities & others. But, pumping money into the market for a long time is just a short term solution to this problem as it may lead to high inflation in the market if economic output does not increase proportionately with increase in cash flow into the market. The worst possible scenario for a central bank is that its quantitative easing strategy may cause inflation without the intended economic growth — stagflation.
To understand stagflation let us go to another story of the Bank of Japan(BOJ). Following the Asian Financial Crisis of 2007, Japan fell into an economic recession. Beginning in 2001, the BoJ (Bank of Japan)_- Japan’s central bank ,began an aggressive Quantitative Easing program in order to curb deflation and to stimulate the economy. The Bank of Japan moved from buying Japanese government bonds to buying private debt and stocks. However, the quantitative easing campaign failed to meet its goals. Between 1995 and 2007, the Japanese gross domestic product (GDP) fell from roughly $5.45 trillion to $4.52 trillion in nominal terms, despite the Bank of Japan’s efforts.
Anyway, the Federal Reserve’s policy helped to normalize the situation. Investors felt safe in this policy and so business started to flourish again. Also a lot of new currency was introduced into the banking system. Slowly, scars of the US crisis began to heal. Thus Fed became the hero of our story. The Fed kept borrowing rates for short term loans near to zero while interest rates on long term loans were kept high. Fed started filling banks with lots of money and was lending many loans. Fed also offered discounts in interest rates and so this new policy of Fed was like a blockbuster movie. So the Fed continued to pump in new cash in banks And slowly the situation went to normalcy.
Until one day in 2013 when the Chairman of Fed announced that in future they would taper down their bond purchases. People began to feel insecure once again, as the Fed was the world’s biggest buyers. So in reaction to this announcement people started selling their bonds as they believed the stock markets would crash. Now why to taper and not completely shut down this Quantitative Easing program? Stock and bond markets do not give a true image of an economy. Suddenly stopping the Quantitative easing program can be dangerous. If quantitative easing is suddenly stopped, money will start flowing out of the bond market which will result in high bond yields. So in order to avoid this central government tapers it slowly instead of sudden shutdown.
Suppose the central bank is buying securities of 12k this year, next year it will buy securities of 10k and so on. But wait a minute why are we discussing all this? Is anything related to India? Answer is of course yes. Investors started to invest in upcoming markets like India. But after the Fed announced to taper down, people felt they no longer needed to invest in emerging markets, instead they should return to the US as stock markets would rise there. So, investors withdrew money overnight and started converting Rupee into Dollar. So there was a sudden withdrawal of foreign currency from the market and it gave a shock to Indian currency. As a result, the value of Indian currency depreciated.
So now you know what “taper tantrum” means. By mere announcement of tapering by the Fed, investors overreacted like a small child whose favourite toy is snatched from them and showed tantrums. Thus this whole event is named Taper Tantrum. But wait, we still haven’t mentioned about Raghuram Rajan, former chief economic advisor to the government of India. Recently he announced in one of his interviews about recurrence of taper tantrum while discussing the global outlook of the economy and the effects of the pandemic on emerging markets “The Federal Reserve has pumped a lot of new money in a bid to support the US economy during Covid19 pandemic. And some of that money has made its way into India. In the event FED scales back this new initiative, maybe we will see the old episode recur once again and so we have to be careful.” these were his words. He said so because as we have seen earlier , due to covid-19 situation the Fed has pumped a lot of money into the economy and just like last time a lot of money has entered Indian market and so if taper tantrum returns India will also suffer.
This was all about the TAPER TANTRUM episode , hope India takes necessary steps to avoid such a situation in future.
