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How the Fed uses the Money Multiplier to fight inflation

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Why do you think the Fed evaluates the money multiplier when making decisions with regard to the money supply? What function does the money supply serve in our economy to influence certain economic variables? Why does the Fed like to fight inflation in our economy and is inflation a concern right now given our current economic situation?

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Solution Summary

This solution explains how the Money Multiplier (MM) is calculated and how the Federal Reserve (Fed) factors it into its calculations when using monetary policy to fight inflation. The economic situation is determined.

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The Money Multiplier (MM) measures the maximum amount of commercial bank money that can be created with a given amount of central bank money. When the Fed injects money into the economy through an open-market purchase of bonds, the money is deposited in commercial banks. This increases the banks' reserves and allows the banks to make new loans, further increasing the money supply. A portion of the new loans will be deposited in other banks, increasing those banks' ...

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