The Impacts of The Tapering Off of QE III

In June of 2013, at the Federal Reserve’s Policy meeting, Chairman Ben Bernanke announce the Fed’s plan to eventually taper off Quantitative Easing (QE) III sent investors and economic analysts into a panic. Bernanke tried to effectively explain the reasoning behind their decision to taper QE, but all that was heard by the market was were their intention to tighten the money. This news is so unnerving to the market because they believe it will only lead to substantial market and economic disruption. During the next couple of days following the June meeting, the market went crazy as stocks dropped by 4 percent and many bonds were sold as interest rates rose. The idea of tapering is so frightening because the US economy is so weak at the moment. The economic growth is around 1.5 percent in the second quarter of 2013. The Fed’s target for inflation was 2 to 2.5 percent and the core personal consumption expenditure has fell to a new low in 50 years of its existence. Couple the fact that the exchange rate is too unstable to provide any relief with the interest rates nearing zero have led to the inflation of asset prices. Because of these economic conditions, if the Fed tries to tighten its money now then the possibility of deflation becomes more realistic which would slow down the economy and also burst the asset bubble. If the Fed decided to taper QE and deflation loomed then there are four possible impacts on the economy. The first impact is that the real interest rate will increase. The nominal rate would be held constant while the inflation decreases and deflation increases. This increase in the real interest rate will severally discourage investment and spending in the economy. The second impact on the economy would be that as direct result of a rising deflation the demand for cash rises