When inflation risks rise following periods of unconventional stimulus, central banks must reverse their expansionary policies and execute Quantitative Tightening (QT) to shrink their balance sheets.
The Two Operational Models of QT Normalization
[Quantitative Tightening (QT)]
  |- Passive QT (Redemption Caps) -> Allows bonds to mature without reinvesting the proceeds
  |- Active QT (Direct Sales) ----> Sells bond portfolios back into the open market

  • Passive QT (Maturity Redemption Caps): The central bank sets a monthly cap on the volume of maturing bonds it will allow to roll off its balance sheet without reinvesting the proceeds, gradually draining liquidity from the financial system.
  • Active QT (Direct Portfolio Sales): The central bank actively sells its bond holdings back into the open market, acceleration balance sheet reduction but introducing risks of market volatility and yield spikes.

 
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