Expansionary and Contractionary Monetary Policy
Demand Management (Monetary Policy)
AO3·AO4·Diagram required
Syllabus requirement
Explains how monetary policy shifts the AD curve to close deflationary or inflationary gaps.
Assessment objectives
AO3 Synthesis and EvaluationAO4 Use of Appropriate Skills
Required diagram: AD/AS diagram showing expansionary monetary policy shifting AD right (closing deflationary gap).AD/AS diagram showing contractionary monetary policy shifting AD left (closing inflationary gap).
Summary
This topic explains how central banks use expansionary and contractionary monetary policy to change the money supply, influence interest rates, and thereby affect aggregate demand. Key tools are open market operations, minimum reserve requirements, the minimum lending (base) rate, and quantitative easing; each tool can either inject liquidity to stimulate growth and reduce unemployment or withdraw liquidity to reduce inflation. Understanding these instruments is essential for explaining shifts in AD on the AD/AS diagram and for evaluating policy effectiveness under different economic conditions.
