When it comes to monetary policy, we tend to simplify everything to a single sentence: “the central bank lowers or raises rates,” but there are also more complex tools that act in depth on the economy. Two of the most important are Quantitative Easing (QE) and Quantitative Tightening (QT).
It is not just an “accommodative” or “restrictive” policy, but direct interventions in financial markets, which change the amount of money in circulation and influence bond yields. In this article we analyze the practical functioning of QE and QT, with particular attention to the effects on short- and long-term bonds.
Quantitative Easing is a strategy adopted by a central bank to stimulate the economy in conditions of too low inflation or stagnation. It is an expansionary monetary policy, used when official rates are already very low and it is no longer possible to cut them further.
How QE works:
The central bank buys financial securities, usually government bonds,
It does this by creating new electronic liquidity, that is, money that did not exist before,
Purchases take place on the secondary market, that is, by purchasing securities already in circulation from banks, funds and other operators,
By increasing the demand for these securities, it increases their price and therefore decreases the yield (interest rate),
Institutions that sell the securities receive cash in return, which they can use for loans, investments, or other purchases.
Main objectives of QE:
Lower interest rates on a wide range of financial instruments,
Stimulate bank lending and consumption,
Promote economic recovery and a moderate increase in inflation.
A concrete example is the ECB’s securities purchase program since 2015, which also included Italian government bonds. This has helped reduce the yield of BTPs, containing the cost of public debt and facilitating access to credit.
#2. What is Quantitative Tightening (QT)
Quantitative Tightening is the opposite of QE: a restrictive monetary policy tool designed to reduce liquidity in circulation and contain inflation. It is usually adopted after periods of intense monetary expansion, when it is necessary to restore equilibrium.
How QT works:
The central bank lets the securities in the portfolio mature without reinvesting the repaid capital,
Or it actively sells securities on the market, thereby absorbing liquidity from buyers,
In both cases, the monetary base is reduced, because the previously created money is withdrawn,
The supply of securities on the market increases, prices fall and yields rise.
Main effects of QT:
Rising interest rates, especially on medium-long term bonds,
More expensive loans, less access to credit,
Cooling of aggregate demand (consumption and investment).
QT is being implemented cautiously, so as not to cause imbalances in financial markets. For example, the Federal Reserve began QT in 2022, gradually reducing its balance sheet by letting securities mature, without initial massive selling.
#3. Short and long term effects
The central bank’s choice to buy or sell short- or long-term bonds has different effects on the yield curve and the real economy:
Type of operation
QE (Quantitative Easing)
QT (Quantitative Tightening)
Short-term securities
– Lower short-term rates – Banks lend more – Increase in short-term credit
– Higher short-term rates – More expensive loans – Consumption and quick loans fall
Long-term securities
– Lower long-term rates – Mortgages and investments cost less – Long-term investments grow
– Higher rates in the long run – More expensive financing – Less investment and less construction
Most QE programs focus on medium-long maturities precisely to influence the final part of the yield curve, which has a stronger impact on growth and future expectations.
Conversely, a well-calibrated QT can restore a steeper curve, giving back scope for traditional monetary policy.
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