Final answer:
When the Irish Central Bank buys government loans, it increases the money supply by increasing bank reserves which then leads to more loans being made available to the public. This can also trigger a chain reaction known as the money multiplier, where banks keep lending out the deposits they receive, further increasing the money supply.
Step-by-step explanation:
When the Irish Central Bank buys government loans, it is engaging in open market operations, which is a key tool used by central banks to regulate the money supply within an economy. Purchasing government loans equates to buying government bonds. When the Central Bank makes a purchase, it pays out money to the individual banks, which increases the reserves of these banks. This additional reserve money leads to an increased capacity for banks to offer loans to the public, which, in turn, expands the money supply in circulation.
For example, if the Central Bank purchases €20 million in bonds from a commercial bank, that bank's reserves increase by the same amount. This bank may then decide to issue €20 million in new loans, which contributes to the total money supply. As these funds are deposited and re-deposited throughout the banking system, other banks will continue to lend, amplify the initial injection of funds, and the overall supply of money grows – an effect known as the money multiplier.
In contrast, when a central bank sells bonds, it collects money from the individual banks which decreases the banks' reserves, thereby contracting the money supply. Therefore, whether the central bank buys or sells bonds directly influences the quantity of money and potentially the interest rates in the economy.