Quantitative Tightening: Lessons from the US and Potential Implications for the EA

Given the decades-high inflation, central banks are complementing conventional rate hikes with quantitative tightening (QT), i.e. a reduction of the sizeable asset holdings accumulated during the quantitative easing (QE) era. In this study, we employ empirical (proxy-SVAR) and structural (medium-scale NK DSGE) frameworks to study the macroeconomic implications of QT. Our empirical findings show that the impact of QT has been relatively muted in the US, suggesting asymmetric effects of QT compared to QE. This finding is corroborated by model simulations, calibrated to the post-pandemic high inflation environment. Nevertheless, QT can partly substitute conventional rate hikes by creating some deflationary pressure and requiring less aggressive conventional policy action. QT produces smaller effects in the euro area (EA) due to the smaller share of private bonds on the ECB’s balance sheet. However, a potential concern for QT in the EA is the proliferation of fragmentation risk. We empirically argue that the deployment of market-stabilisation QE can be used to stabilise sovereign spreads without creating considerable inflationary pressure in case QT leads to disorderly market dynamics.