Question

Expansionary policy consist of either monetary policy or fiscal policy. Explain expansionary monetary policy and its effect on Aggregat Demand (with diagram)

Answer 1

The goal of the expansionary monetary policy is to create domestic demand and move the economy out of recessionary gap. The policy infuses more money into the system which increases the bank's capacity to do lending at higher level. People starts borrowing money and see rise in their real purchasing power. They decides to spend this extra money on goods and services.

Eventually, the Aggregate Demand increases induced by higher consumption expenditure.

Initally equilibrium occurs at point E where P* and Q* are the equilibrium prices and output. The AD curve shifts right to AD1 due to expansionary monetary policy. There is an upward movement on the SRAS curve from Point E to E1.

Real GDP and price both increases to Q1 and P1.

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