A policy that might occur after a period of quantitative easing if there are signs the economy is over-heating. It would involve the central bank selling the financial assets it acquired via quantitive easing to increase supply and reduce the value of these assets. It should help to slow economic growth and help control rising inflation as it will reduce availability of credit, increase borrowing costs and reduce the value of assets.
Below is a diagram to show how this policy works. In this instance, the central bank has already engaged in some form of QE and this has removed the negative output gap for the economy but has now created a positive output gap, putting the economy on an inflation alert. Therefore this policy aims to move the economy back to the full employment level of output to keep inflation in check and in line with the CPI inflation target. This is highlighted by a small inward shift of the aggregate demand curve to AD2. Restoring the economy to it's capacity.
