Central banks’ efforts to reduce their asset holdings, known as quantitative tightening (QT), have had a limited impact on interest rates and other financial indicators, according to a new study.
The research, focusing on seven major economies including the US and the eurozone, found that QT’s direct effect on government bond yields was minimal, ranging from 4 to 8 basis points for longer-term maturities. In the US, the impact was close to zero due to the Fed’s gradual approach.
The study acknowledges that focusing solely on short-term market movements might miss long-term effects. However, the authors conclude that QT’s impact is significantly smaller compared to the significant influence of quantitative easing (QE) programs that initially expanded central bank holdings.
This finding, presented at the University of Chicago Booth School of Business, suggests that central banks can proceed with unwinding asset purchases with greater confidence. The research also highlights the potential asymmetry between the effects of QE and QT, likely due to differing economic contexts when these policies are implemented.
While acknowledging the success of QE in lowering interest rates and boosting equities, the study underscores the potentially weaker impact of QT in reversing these effects. This, the authors suggest, could be due to various economic and market conditions surrounding each policy.
Central banks, including the Fed, are now navigating the pace of balance sheet reduction, mindful of the 2019 episode where a too-rapid decline triggered market turmoil. The authors acknowledge the possibility of similar disruptions in the ongoing process, emphasizing the challenge of identifying potential tipping points where the current smooth adjustment might evolve into a liquidity crisis.