Quantitative Easing and Tightening

When central banks cut short term interest rates to near zero and still want to support the economy, they can buy large amounts of bonds. This is quantitative easing (QE). It pushes down long term interest rates, adds money to the financial system and supports asset prices. The reverse, quantitative tightening (QT), shrinks the central bank's balance sheet by letting bonds mature without replacing them or by selling them. QE and QT have become major drivers of bond yields, liquidity and risk assets since 2008.

How QE works#

1. The central bank creates reserves (new electronic money) and uses them to buy bonds, usually government bonds and sometimes mortgage backed securities or corporate bonds.
2. Sellers, often banks and investors, receive reserves or deposits.
3. Bond prices rise and yields fall, especially at longer maturities.
4. Investors move into other assets such as corporate bonds and stocks in search of returns (the portfolio balance effect).
5. Signalling: QE shows the central bank's commitment to keeping rates low.

QE → bond purchases → long term yields ↓ → borrowing costs ↓ and asset prices ↑

Major QE programmes#

Quantitative tightening#

QT reduces the central bank's bond holdings, mainly by letting maturing bonds roll off without reinvestment, sometimes by active sales (as the Bank of England did from 2022).

Effects on markets#

Research has estimated that the Fed's early QE programmes lowered 10 year Treasury yields by roughly 0.5 to 1 percentage point in total, though estimates vary widely.

Criticisms and debates#

• Asset price inflation: QE may have widened wealth inequality by lifting asset prices.
• Distorted markets: central banks becoming dominant buyers can reduce price signals.
• Exit difficulty: unwinding QE can cause volatility, as in the 2013 "taper tantrum", when hints of slower purchases pushed US 10 year yields up about one percentage point within months.
• Central bank losses: when rates rise, central banks holding low yield bonds can face losses.
• Fiscal links: QE can blur lines between monetary and fiscal policy. See Monetary vs Fiscal Policy.

Watching the balance sheet#

Traders track weekly central bank balance sheet data (the Fed's H.4.1 release), bank reserves, the overnight reverse repo facility and the Treasury General Account to gauge liquidity conditions, which some analysts link to risk asset performance.

Frequently asked questions#

What is quantitative easing?#

A central bank policy of buying large amounts of bonds to lower long term interest rates and add money to the financial system.

What is quantitative tightening?#

Reducing a central bank's bond holdings, usually by letting bonds mature without replacing them, which removes liquidity and can raise long term yields.

Does QE cause inflation?#

Not necessarily. QE after 2008 did not cause high consumer inflation, but QE combined with large fiscal stimulus and supply shocks contributed to inflation in 2021 and 2022.

Next, learn how to trade data releases in Trading Economic Releases.