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How does monetary policy affect aggregate demand in the short and long runs? 

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armyof32000 | (Level 1) Salutatorian

Posted July 29, 2013 at 5:46 PM via web

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted July 29, 2013 at 6:12 PM (Answer #1)

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In the short run, monetary policy can have a relatively significant impact on AD.  Let us look, for example, at what happens when the central bank engages in expansionary monetary policy.  This will often take the form of lowering interest rates.  When interest rates drop, consumers will start to buy more bit ticket items fairly soon.  Once they are aware of the lower rates, they will be more likely to buy things like cars and houses that usually have to be bought using loans.  This increase in buying will cause an increase in AD.

In the long run, however, this increase in AD should not be sustained.  People will buy more goods when the interest rates fall.  But this effect will not last forever.  Once people have bought their cars and houses, they will not keep on buying more simply because the interest rates are lower.

What this means is that monetary policy can give the economy a jolt in the relatively short term.  However, it cannot create a situation where AD will rise in the long term.

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