Quantitative tightening (QT) is a monetary policy pursued by central banks to reduce the amount of liquidity circulating in the economy. It is the opposite of quantitative easing (QE), a policy used to inject money into the economy in times of slowdown or crisis. Quantitative tightening generally takes place after a period of monetary expansion (QE) and aims to normalize financial conditions and combat inflation by reducing the size of the central bank’s balance sheet.

How Quantitative Tightening works

QT works by reversing the mechanisms used during QE, i.e. by reducing the central bank’s balance sheet. During QE, central banks buy financial assets, such as government bonds or mortgage-backed securities, to inject liquidity into the economy and support growth. During QT, on the other hand, they let these assets expire or actively sell securities, thereby withdrawing liquidity from the economy.

Here’s how the QT works:

1. Non-renewal of bonds: When a bond held by the central bank reaches maturity, the bank chooses not to reinvest the funds in new securities. This process progressively reduces the amount of assets held by the central bank and diminishes liquidity in the financial system.
2. Active asset sales: In some cases, the central bank can also actively sell assets, such as bonds, on the market. This directly removes liquidity from the system in exchange for financial assets.
3. Rising interest rates: QT can also be accompanied by increases in key interest rates, which raise the cost of borrowing for banks and consumers, thereby reducing demand for credit and curbing inflation.

Quantitative Tightening objectives

The main aim of QT is to reduce excess liquidity in the economy to prevent economic imbalances, such as inflation or the formation of speculative bubbles. Here are some of QT’s main objectives:

1. Controlling inflation: After a period of QE, which can cause the economy to overheat and prices to rise, QT aims to reduce inflation by withdrawing excess liquidity from the financial system.
2. Monetary policy normalization: After a prolonged period of accommodative monetary policy (low interest rates and QE), the central bank uses QT to return monetary conditions to a more normal level, by reducing the size of its balance sheet and gradually raising interest rates.
3. Preserving financial stability: In times of excess liquidity, investors can take excessive risks, such as speculative investments or excessive leverage. QT helps mitigate these risks by making credit more expensive and reducing access to liquidity.

Impact of Quantitative Tightening on markets

Quantitative tightening can have significant effects on financial markets and the economy as a whole. By reducing the amount of liquidity available, it influences interest rates, asset values and investor behavior.

1. Rising interest rates: By withdrawing liquidity from the system, QT tends to push up interest rates, particularly bond yields. This increases the cost of borrowing for businesses and consumers, which can slow economic growth.
2. Falling prices of financial assets: QT can lead to falling prices of financial assets, such as stocks and bonds. With higher interest rates, investors may demand higher yields to hold stocks, and higher bond yields lead to lower bond prices.
3. Strengthening currency values: By making access to currency more restricted, QT can lead to an appreciation of the national currency. For example, if the U.S. Federal Reserve (Fed) pursues a QT policy, the U.S. dollar may strengthen against other currencies due to reduced dollar liquidity.

Quantitative Tightening after the 2008 financial crisis

Following the 2008 financial crisis, many central banks, including the US Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of England, implemented quantitative easing policies to support their economies. This led to a massive expansion of central bank balance sheets.

Once economies had stabilized and were on the road to recovery, the Fed began to normalize its monetary policy by implementing a quantitative tightening program from 2017. The process mainly involved gradually reducing