Question

In details, give explanation of how a central bank might influence domestic money supply. Also, illustrate to why it is challenging for central banks in an economy with low income

Answer 1

Central bank raises money supply with the help of open market operations by buying or selling governmeny securities and bonds. If Central banks buy bonds from the market, they pay money in the exchange of it to the investors which raise the circulation of money in the economy and hence the money supply

If Central banks sells bonds into the market, they accept money in the exchange of it which absorb all extra cash from the market and reduce the money supply in the economy.

It is extremely difficult for Central bank to sell bonds in the market when people have low income because people do not have enough money to pay in exchange of bonds. To raise money supply in such a case, Central bank have to lower reserve requirement ratio or reduce discount lending.