Reply To: Fed Tapering and Interest Rates


Armed with economic theory, each of us can make a prediction about how high interest rates will go when the Fed stops QE3 by using our judgment as to the likely impact of the different causal factors. Since our judgments differ, we will make different quantitative predictions even if we accept the same theory of cause and effect.

Given that interest rates have nearly doubled since Bernanke hinted that the Fed might begin tapering QE3 by the end of the year, it seems that the effect will be large. But the reason, I think, is not because by tapering QE3 that monetary inflation through credit expansion will slow down. Instead, I think, the effect has been on the demand side in changing investor expectations. Because investors have now adjusted their investments to accommodate their changed expectations, when the Fed actually tapers QE3 there will be less effect at that time than there would have been had Bernanke not made his announcement.