Monetary policy can affect aggregate demand through interest rates from "summary" of Principles of Macroeconomics by N. Gregory Mankiw
Monetary policy is a powerful tool that policymakers use to influence the overall level of economic activity. One way in which monetary policy can impact the economy is through its effect on interest rates. Interest rates play a crucial role in determining the level of investment and consumption in the economy. When the central bank, such as the Federal Reserve in the United States, decides to implement expansionary monetary policy, it typically involves lowering interest rates. Lower interest rates make it cheaper for businesses and consumers to borrow money, which, in turn, stimulates investment and consumption. With lower borrowing costs, businesses are more likely to invest in new equipment and expand their operations, while consumers are more inclined to purchase big-ticket items like homes and cars. As businesses invest more and consumers spend more, aggregate demand in the economy increases. This increase in aggregate demand leads to higher levels of economic activity, such as increased production and job creation. Ultimately, the goal of expansionary monetary policy is to boost economic growth and reduce unemployment. Conversely, when the central bank decides to implement contractionary monetary policy, it typically involves raising interest rates. Higher interest rates make borrowing more expensive, which tends to dampen investment and consumption. Businesses are less likely to invest in new projects, and consumers are less likely to make big purchases when borrowing costs are high. As a result, aggregate demand in the economy decreases, leading to lower levels of economic activity. This reduction in economic activity can help to cool down an overheated economy and prevent inflation from rising too rapidly. By adjusting interest rates, the central bank can effectively influence the level of aggregate demand in the economy and steer it towards a desired level of economic growth and stability.
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