We evaluate the macroeconomic effects of long-term sovereign bond purchases by the central bank when the monetary policy rate is at its lower bound, by simulating a general equilibrium model for the euro area. Central bank purchases favour a decline in long-term sovereign bond interest rates and, thus, induce banks to sell long-term sovereign bonds and increase loans to households and firms. The lowering of the tax wedge and stronger economic activity would favour labour demand. The unemployment rate would decrease.
When the monetary policy rate is at its lower bound and the economy is hit by recessionary shocks, purchases of long-term sovereign bonds contribute to raising inflation close to the target. When expansionary shocks hit the economy, leading to an increase in inflation, the central bank can react in an effective way by substantially increasing the policy rate, instead of selling long-term sovereign bonds.
Published in 2023 in: International Finance, v. 26, 1, pp. 19-35.
