Commercial banks in Country A hold no excess reserves. The required reserve ratio is 0.1. The central bank of Country A has become concerned about a steep decline in investment spending.

1)Calculate the simple money multiplier.
2) Identify an open market operation that Country as central bank is likely to implement to address the decline in investment spending.

1. Money multiplier = 10

2. Central bank to buy bonds in order to increase money supply and allow citizens to invest the excess money

Explanation:

1. Money Multiplier  = 1 / reserve ratio

          = 1 / 0.1

          = 10

2. Open market operations are a tool used by the central bank to control money supply. The central bank can either buy government bonds in order to increase money supply or sell government bonds in order to decrease money supply. To counter the declining investment spending, the bank has to increase money supply for the country and allow citizens to invest the excess money they will now have at their disposal. The citizens will either invest / save or consume the money. Increasing money supply is done by buying the government bonds.  

(a).

Money Multiplier = 1 / (required reserve ratio)

1 / 0.1 = 10

Money multiplier: 10

(b).

The central bank could implement an open market purchase of treasury bonds to increase the money supply and thus decrease interest rate and increase investment.

Explanation:

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