Which policy tool uses monetary policy to manage aggregate demand by influencing the money supply and interest rates?

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

Answer: (C)

Monetary policy is the tool that uses changes in the money supply and interest rates to manage aggregate demand. The central bank influences AD by adjusting how much money banks can lend and the cost of borrowing. If it wants to boost demand, it increases the money supply and lowers interest rates, making loans cheaper and encouraging more spending and investment. If it wants to slow demand, it tightens the money supply and raises interest rates, making borrowing more expensive and reducing spending. This is distinct from fiscal policy, which uses government spending and taxation to affect AD. The terms expansionary and contractionary describe how monetary policy is applied: expansionary to raise AD, contractionary to lower AD.