Basic Points

• QT (Quantitative tightening), being the opposite of QE (quantitative easing), is when a central bank deploys monetary policy to combat inflation by decreasing the money supply and the affordability of credit (borrowed capital). 
• Central banks would want to deploy QT in order to control an overheated economy (too much growth) or to reduce inflation. 
• It aims to slow down growth and inflation by increasing yields on fixed-income products. This makes access to credit more expensive which means less expansion for companies. It also weighs on stocks because those higher yields become relatively more attractive. 
• QT is executed actively by the outright selling of treasuries or other fixed-income products. And it is executed passively when these fixed-income products are simply left to expire without being replaced. 
• On the other hand, passive QT has less impact on the stability of an economy but it can still damage an economy by shocking its ability to grow. And it can damage banks because their generally large holding in fixed-income products will lose value. 

All levels: Passive QT

While being the opposite of QE, the execution and magnitude are usually not symmetrical. For example, beginning in 2022 and continuing to 2023, the Federal Reserve (US central bank) began a passive QT campaign. As opposed to the outright selling of treasury notes, bills, and various bond types, passive QT allows a central bank's balance sheet to shrink by letting its assets expire and then not replacing them. This provides less shock on the economic system than selling fixed income securities outright, which would drive bond prices down more dramatically than the market (and regional banks) might be able to handle. 

The dynamic is that sharply-dropping bond prices would increase bond yields because higher yields become available for cheaper bonds. And with higher yields for lower principal investments, as well as higher interest being paid to customers who are holding cash in checking accounts, the risk of holding equities becomes comparatively less attractive. This in turn leads to a rotation out of equities, which causes stock prices to drop.

Strictly in terms of combating inflation, a secondary benefit of QT is that plummeting stock prices means that there is wealth destruction, which translates to demand destruction, and therefore lower prices (achieving deflation). But if too much wealth is destroyed, then for obvious reasons this could be catastrophic for an economy. And therefore, passive QT is preferred (over active QT in which securities would be sold outright). 

QT is also being executed at a significantly smaller total magnitude than QE was. As forecasted by UBS: "QT will be much smaller than QE. The Fed’s balance sheet will not fall back to pre-crisis levels. The balance sheet expanded fivefold from USD 900bn pre-crisis to a peak in 2017 of USD 4.5trn. We believe QT will only reduce the balance sheet to about USD 3.5trn. With the reduction so much smaller than the expansion that preceded it, the direct impact of QT is likely to be significantly less than the impact of QE." However, this asymmetry does raise questions of how the central bank balance sheets would not keep growing indefinitely over the long run. Perhaps very extended periods of passive QT will eventually become justifiable.