I was just wondering if anyone could tell me what expansionary and contractionary monetary policy means. I know that expansionary fiscal policy is spending and taxation policy designed to increase the aggregate demand, and contractionary is the opposite. Do the terms mean the same for monetary policy? i.e. designed to increase/reduce AD. Just seems like there's more of a direct link for fiscal policy (from AD = C + I + G + X - Z). And would changing the money supply have any effect on AD? Thinking about the IS-LM model, the money supply feeds into the LM curve, and AD feeds into the IS curve but they don't feed into one another (...do they?) Can anyone put this in simple terms for me?!
From how I see it: Expansionary monetary policy is designed to increase the money supply Contractionary monetary policy is designed to reduce the money supply These are achieved through open market operations, reserve requirements, discount rates and credit controls. Changing the money supply changes the interest rate and hence has an effect on general consumption and investment and therefore will affect national income in this way. They don't feed directly into one another but the effect on AD is indirectly shown by the equilibrium point on the IS-LM curve changing due to the shift in the LM curve resulting from the change in the money supply. I am open to corrections with the big day looming however!
Thanks for your response This was really useful. As ever I was confusing myself - need to remember that the 45 degree line diagram for the AD curve is drawn for a fixed interest rate (presumably MS too) and the Money supply and demand curves are drawn for a fixed level of national income. Then it's the IS-LM curves that show the interactions.
