Which policy reduces aggregate demand?

Which policy reduces aggregate demand?

• A. Expansionary monetary policy
• B. Fiscal policy
• C. Productivity policy
• D. Contractionary monetary policy

Answer: (D)

Contractionary monetary policy reduces aggregate demand by tightening money conditions. When the central bank lowers the money supply or raises interest rates, borrowing becomes more expensive and saving looks more attractive. As a result, households cut back on big purchases and firms delay or reduce investment. With consumption and investment falling, overall spending in the economy drops, so aggregate demand shifts left. Expansionary monetary policy would raise AD by boosting borrowing and spending, while productivity policy affects long-run potential output rather than current demand, and fiscal policy can only reduce AD if government spending falls or taxes rise. The tightening of monetary policy is the direct way to reduce total demand in the economy.

Contractionary monetary policy reduces aggregate demand by tightening money conditions. When the central bank lowers the money supply or raises interest rates, borrowing becomes more expensive and saving looks more attractive. As a result, households cut back on big purchases and firms delay or reduce investment. With consumption and investment falling, overall spending in the economy drops, so aggregate demand shifts left.

Expansionary monetary policy would raise AD by boosting borrowing and spending, while productivity policy affects long-run potential output rather than current demand, and fiscal policy can only reduce AD if government spending falls or taxes rise. The tightening of monetary policy is the direct way to reduce total demand in the economy.