Explanation

When a central bank purchases bonds (through open market operations), it injects money into the banking system. Here's how this works:

1. Open Market Operations: When the central bank buys bonds from commercial banks or the public, it pays for these bonds by creating new bank reserves.

2. Money Creation Process: The newly created reserves allow commercial banks to increase their lending capacity, which leads to deposit creation and expansion of the money supply through the money multiplier effect.

3. Contrast with Other Options:

   • Option B (increases the policy rate): This is contractionary monetary policy. Higher policy rates make borrowing more expensive, reducing lending and decreasing money supply.
   • Option C (raises the reserve requirement): This reduces the money multiplier effect by requiring banks to hold more reserves against deposits, thereby decreasing the money supply.

4. Key Mechanism: Bond purchases increase bank reserves → banks have more excess reserves → banks can make more loans → new deposits are created → money supply expands.

Therefore, central bank bond purchases are an expansionary monetary policy tool that increases the money supply.