Demand-Side Policies (HL)

Demand-side policies aim to influence aggregate demand to achieve the macroeconomic objectives of full employment, price stability, and growth. They come in two forms: monetary policy and fiscal policy.

Monetary policy

Monetary policy is conducted by the central bank, which adjusts the interest rate and the money supply. The main tool is the policy interest rate. To stimulate a weak economy (expansionary or "loose" policy), the central bank lowers interest rates. Cheaper borrowing encourages consumption and investment, reduces saving, and tends to weaken the currency and boost net exports, so AD shifts right. To restrain an overheating economy with high inflation (contractionary or "tight" policy), it raises interest rates, and AD shifts left. Central banks in many countries pursue inflati