Influence of Monetary and Fiscal Policy on Aggregate Demand Notes

Aggregate Demand (AD)

Total spending in the economy at various price levels, represented as Y = C + I + G + NX.

Wealth Effect

Lower price levels increase real wealth, boosting consumption and shifting AD right.

Interest-Rate Effect

Lower prices reduce money demand, decreasing interest rates, which stimulates investment.

Exchange-Rate Effect

Lower prices can weaken the currency, boosting exports and increasing net exports.

Aggregate Supply (AS)

Total production output at different price levels, typically upward sloping.

Central Bank's Role

Controls money supply through tools like open market operations to influence interest rates and aggregate demand.

Keynes’s Theory of Liquidity Preference

Explains how money supply and demand interact to determine interest rates; an increase in money supply lowers interest rates.

Fiscal Policy

Government spending and taxation influencing AD by changing government expenditures and taxes.

Multiplier Effect

Increased government spending leads to greater income, amplifying the impact of initial spending increases.

Crowding-Out Effect

Increased government spending leads to higher interest rates, reducing private investment spending.

Automatic Stabilizers

Fiscal mechanisms that automatically trigger changes in spending or taxes in response to economic fluctuations.

Case Studies in Policy

Instances where fiscal policies, such as tax cuts and stimulus spending, were utilized to combat economic recessions.

Economic Stabilization

The use of active fiscal and monetary policies to stabilize aggregate demand during economic fluctuations.