What Is the Fed’s ‘Quantitative Tightening’ and What Phasing It Out Would Mean

The US Federal Reserve has begun the process of phasing out its effort to remove trillions of dollars of excess cash from the financial system – a leftover of its injection of emergency economic support during the pandemic. The effort, known as quantitative tightening, has been under way for two years, and officials want to make sure to stop it before they cause the kind of financial disruptions caused by the last round of QT, in 2017-2019. There’s no specific timeline yet, however, and market participants disagree on how much longer QT can last without causing more disturbances.

The easy answer is that it’s the opposite of quantitative easing, or QE. With QE, a central bank typically buys bonds, which helps to drive down longer-term interest rates — complementing the cuts to the policy rate, which is usually an overnight benchmark. A central bank essentially creates money out of thin air to do that, with the purchases having the effect of increasing the supply of bank reserves in the financial system. That extra boost of reserves, in theory, supports banks’ appetite to keep extending credit, which aids the economy. When a central bank shifts to QT, it begins withdrawing that extra cash from bond markets.