Effects of the 2013 ‘Taper Tantrum’ Linger Over Fed Policy

WASHINGTON — Jerome H. Powell, the Federal Reserve chairman, says he still carries the scars of the Fed’s missteps in the spring of 2013.

That June, Mr. Powell, then a relatively new member of the Fed’s board, joined colleagues in urging Chairman Ben S. Bernanke to announce that the Fed finally planned to gradually reduce its economic stimulus campaign.

Mr. Powell anticipated that markets might not like Mr. Bernanke’s message, but he said he was even more worried about the consequences of extending the central bank’s monthly purchases of Treasury securities and mortgage-backed bonds. Mr. Powell said the Fed was stuck on the edge of a rooftop. “We’ve got to jump,” he told his colleagues, according to transcripts of the Fed’s 2013 meetings, which the central bank published Friday. “There is no risk-free path.”

Mr. Bernanke’s comments at a news conference later that day, suggesting the economy was strong enough for the Fed to begin tapering its monthly purchases before the end of the year, triggered a minor panic in financial markets, dubbed the “taper tantrum.”

Mr. Powell said earlier this month that the episode continued to exert a significant influence on his management of monetary policy.

“The taper tantrum left scars on anybody who was working at the Fed at that time,” Mr. Powell said at a joint appearance in Atlanta with Mr. Bernanke and the former Fed chairwoman Janet L. Yellen.

But the lesson Mr. Powell took from the episode, that the Fed should strive to be clear and predictable as it retreated from its stimulus campaign, is now itself causing angst in financial markets. Some investors argue the Fed is showing too little flexibility in reducing its bond holdings, by sticking to a plan that it announced more than a year ago.

Mr. Powell, who joined the Fed’s board in May 2012, expressed doubts from the outset about the Fed’s purchases of several trillion dollars in Treasuries and mortgage-backed securities, part of its broader campaign in the wake of the financial crisis to reignite economic growth by holding down borrowing costs. The Fed ultimately amassed a $4.2 trillion portfolio of United States Treasury debt and mortgage-backed securities as part of a strategy known as quantitative easing.

He voted in favor of the Fed’s final round of asset purchases, known as QE3, which began in September 2012, but he told his colleagues that he did so “with a certain lack of enthusiasm.” He was particularly concerned that the Fed’s bond buying would undermine financial stability.

The 2013 transcripts, which the Fed released after a standard five-year delay, show that Mr. Powell’s concerns remained strong enough at the Fed’s first meeting of the year, in January, that he argued for an end to the program in 2013, even if unemployment remained high.

“I believe we should adjust our purchases downward, with a view to ending them before year-end, whether or not we see a substantial improvement in the labor market,” Mr. Powell said.

During the first half of 2013, Mr. Powell and two fellow governors, Elizabeth Duke and Jeremy Stein, continued to raise their concerns with Mr. Bernanke. Mr. Powell, in particular, argued there was little evidence continued bond-buying was delivering significant economic benefits.

At the Fed’s March meeting, Mr. Powell quoted an estimate that every $500 billion of bond purchases might create 200,000 jobs — “enough to move the recovery forward by about a month,” he said.

On the other side of the ledger, Mr. Powell said the Fed was encouraging financial speculation by holding down interest rates and by removing safer assets from the market, pushing investors into riskier investments. “We have put in place strong incentives for risk-taking,” he cautioned colleagues at the March meeting. “We should expect that dealers and investors will take more and more risk as time passes.”

Mr. Powell and the other governors were particularly concerned the Fed had set no limit on the bond purchases, instead declaring it would continue until labor market conditions improved substantially. The Fed also said that it would adjust its bond-buying in response to economic conditions. Officials conceived of the bond-buying program as similar to the Fed’s management of interest rates.

In May, as the economy gained strength, Mr. Bernanke agreed to acknowledge that progress by telling Congress that the Fed might reduce its bond purchases in the coming months.

At the Fed’s June meeting, Mr. Powell and his allies pressed Mr. Bernanke to reinforce the message.

“It will be very important to leave the markets feeling much more certain about the Committee’s intentions,” Mr. Powell said, according to the transcripts. “It’s important that the Committee, by which I really mean the Chairman, assert strong leadership to the markets on this issue at this time.”

Mr. Powell acknowledged that the Fed was facing a challenge in explaining its plans. Economic growth had repeatedly fallen short of the Fed’s expectations and millions of Americans remained out of work. Mr. Bernanke would need to explain why the Fed thought the economy needed less help.

But he expressed confidence in Mr. Bernanke. “Much rests on the shoulders of the Great Communicator,” he said, referring to the chairman. Then he compared Mr. Bernanke to LeBron James.

Mr. Bernanke flubbed his lines at the post-meeting news conference, leaving investors confused about the Fed’s intentions. Asset prices reacted as if the Fed was significantly reducing its stimulus plans. The yield on the benchmark 10-year Treasury rose by more than a percentage point over the summer.

The Fed finally announced it would begin to taper its bond purchases in December 2013.

The market’s reaction convinced Fed officials, including Mr. Powell, that the Fed should handle its balance sheet differently from its benchmark interest rate. When the Fed began to reduce its bond holdings in 2017, it published a detailed timetable for those reductions, and it has stayed on schedule.

The taper tantrum, Mr. Powell said in Atlanta, is “one of the reasons why the balance sheet is supposed to be in the background, gradual and predictable, paint drying, as opposed to an active tool.”

But investors increasingly are divided on the wisdom of that approach. Some see little evidence the Fed’s plodding approach is disrupting financial markets. Others say the Fed, despite moving slowly and predictably, is still making waves.

“We believe balance sheet normalization played an important role in the late 2018 market volatility,” Morgan Stanley’s economics team wrote in a research note on Friday. Just as Mr. Powell argued that the Fed’s bond-buying encouraged investors to take risks in 2013, Morgan Stanley said that the Fed’s retreat was now discouraging risk-taking.

Mr. Powell and other Fed officials have said they see no evidence that the Fed’s balance sheet retreat is contributing to volatility in financial markets. At the same time, they have emphasized in recent appearances that the Fed “would not hesitate” to adjust the pace of its retreat if it reached the conclusion that changes were necessary.

But the history of the taper tantrum suggests that, for Mr. Powell, that is likely to be a high bar.

Sign Up for Our Newsletters

Get notified of the best stories everytime.

You May Also Like

ICI reports offer insights into the characteristics of IRA investors

Posted by Jon Vogler, Senior Analyst, Retirement Research on Oct 5, 2018,…

New tax reform bill includes retirement provisions

Posted by Jon Vogler, Senior Analyst, Retirement Research on Sep 20, 2018,…

Opinion | The Secret Lives of Central Bankers

A few years ago, a senior Japanese central banker let me in…

What may LIBOR’s phase-out mean for investors?

Posted by Justin Mandeville, Portfolio Manager and Jacob Habibi, Senior Analyst on…