Purchases of government bonds

A central bank can make its monetary policy more expansionary by purchasing government bonds on the secondary market. The purpose of such purchases is to reduce general interest rates in the economy, partly through the so-called portfolio channel.

This means that when the rate on safe assets falls as a result of the central bank's purchases of government bonds, it becomes more attractive for investors to seek other assets. In this way, the lower government bond interest rates spread to other parts of the financial markets via the portfolio channel. The low interest rates in turn contribute to allowing banks to cut their lending and deposit rates, which increases companies' propensity to invest, at the same time as households have increased incentive to consume. Both households' and companies' wealth increase as a result of asset prices rising. All in all, general demand in the economy increases and gradually so will inflation.

Updated 05/01/2018

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