A policy tool that aims to decrease the money supply.
Quantitative tightening is a monetary policy tool used by central banks to decrease an economy’s money supply. Quantitative tightening typically follows a period of quantitative easing, during which central banks expanded their balance sheets by purchasing financial assets like government bonds.
Quantitative tightening is an unwinding of the policy decisions that a central bank took during a period of quantitative easing. So, while during quantitative easing a central bank would’ve bought bonds to increase money in circulation and support long-term lower interest rates, during quantitative tightening the opposite is true. Here’s how that works in practice.
Asset sales: the central bank begins to sell the financial assets it had previously purchased during quantitative easing – including bonds.
Reducing bank reserves: when the central bank sells these assets, the proceeds are removed from the monetary system, which decreases the amount of money in circulation.
Discouraging borrowing and investment: higher interest rates can make borrowing more expensive for businesses and individuals, and it also makes saving more attractive – potentially slowing down investment and economic activity.
Central banks may choose to implement quantitative tightening when they believe the economy has recovered sufficiently from a previous economic downturn or financial crisis.
By implementing quantitative tightening, central banks aim to reverse the expansion of the money supply and raise interest rates to more normal levels. This is done to prevent inflation, cool down an overheated economy, and maintain overall financial stability.
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