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mntl-text-block">›</span></li> <li id="mntl-breadcrumbs__item_3-0" class="comp mntl-breadcrumbs__item mntl-block"><a href="https://www.thoughtco.com/economics-4133521" rel="nocaes" id="mntl-text-link_7-0" class="mntl-text-link mntl-breadcrumbs__link" data-tracking-container="true" ><span class="link__wrapper">Economics</span></a> <span id="breadcrumbs__separator_3-0" class="comp breadcrumbs__separator mntl-text-block">›</span></li> <li id="mntl-breadcrumbs__item_4-0" class="comp mntl-breadcrumbs__item mntl-block"><a href="https://www.thoughtco.com/supply-demand-4133514" rel="nocaes" id="mntl-text-link_8-0" class="mntl-text-link mntl-breadcrumbs__link" data-tracking-container="true" ><span class="link__wrapper">Supply & Demand</span></a> <span id="breadcrumbs__separator_4-0" class="comp breadcrumbs__separator mntl-text-block">›</span></li></ul> <div id="article-heading_1-0" class="comp article-heading mntl-article-header"> <h1 class="article-heading type--lion">Expansionary Monetary Policy and Aggregate Demand</h1> </div></div> </div><div class="loc article-post-header"><div id="post-header-social-block_1-0" class="comp post-header-social-block mntl-block"><div id="social-share-block_1-0" class="comp social-share-block mntl-block"><ul id="social-share_1-0" class="comp social-share mntl-social-share share" data-title="Expansionary Monetary Policy and Aggregate Demand" document="StructuredContentDocumentEx{parent=BaseDocumentEx{templateType=STRUCTUREDCONTENT, documentId=1146843, bestTitle='Expansionary Monetary Policy and Aggregate Demand'}}" data-description="Here's an examination of what happens when we have cost of living allowances and inflation in aggregate demand and aggregate supply models." data-tracking-container="true"> <li class="share-item share-item-facebook"> <span 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mntl-attribution__item--has-date"> <span class="mntl-attribution__item-descriptor">By</span> <div data-tooltip="Mike Moffatt, Ph.D., is an economist and professor. He teaches at the Richard Ivey School of Business and serves as a research fellow at the Lawrence National Centre for Policy and Management." tabindex="0" data-inline-tooltip="true"> <a href="https://www.thoughtco.com/mike-moffatt-1145885" rel="nocaes" data-trigger-link="true" class="mntl-attribution__item-name" tabindex="-1" >Mike Moffatt</a> <div id="mntl-author-tooltip_1-0" class="comp mntl-author-tooltip mntl-tooltip mntl-group "> <div class="mntl-author-tooltip__top mntl-author-tooltip__top--no-image"> <div id="mntl-author-tooltip__name_1-0" class="comp mntl-author-tooltip__name mntl-attribution__item "> <a href="https://www.thoughtco.com/mike-moffatt-1145885" rel="nocaes" class="mntl-attribution__item-name" tabindex="0" >Mike Moffatt</a> </div> <span id="mntl-author-tooltip__job-title_1-0" class="comp mntl-author-tooltip__job-title mntl-text-block">Professor of Business, Economics, and Public Policy</span> <ul id="mntl-author-tooltip__education_1-0" class="comp mntl-author-tooltip__education mntl-block"><li id="mntl-author-tooltip__education-item_1-0" class="comp mntl-author-tooltip__education-item mntl-text-block">Ph.D., Business Administration, Richard Ivey School of Business</li> <li id="mntl-author-tooltip__education-item_2-0" class="comp mntl-author-tooltip__education-item mntl-text-block">M.A., Economics, University of Rochester</li> <li id="mntl-author-tooltip__education-item_3-0" class="comp mntl-author-tooltip__education-item mntl-text-block">B.A., Economics and Political Science, University of Western Ontario</li></ul> <div class="mntl-author-tooltip__bio"> Mike Moffatt, Ph.D., is an economist and professor. He teaches at the Richard Ivey School of Business and serves as a research fellow at the Lawrence National Centre for Policy and Management. </div> </div> <div class="mntl-author-tooltip__bottom"> <span class="mntl-author-tooltip__learn-more-text">Learn about our</span> <a href="/about-us-4779650#toc-editorial-guidelines" rel="nocaes" class="mntl-author-tooltip__learn-more-link" >Editorial Process</a> </div> </div></div> </div> <div class="mntl-attribution__item-date">Updated on February 15, 2018</div></div> </div></div> </div><div class="loc article-content"><div id="article-content_1-0" class="comp article-content mntl-block"><div id="mntl-sc-page_1-0" class="comp mntl-sc-page mntl-block structured-content expert-content" data-sc-sticky-offset="85" data-sc-ad-label-height="24" data-sc-ad-track-spacing="100" data-sc-min-track-height="250" data-sc-max-track-height="600" data-sc-breakpoint="50em" data-sc-load-immediate="3" data-sc-content-positions="[1, 1050, 1250, 1550, 1950, 2350, 2750, 3150]" data-bind-scroll-on-start="true"><p id="mntl-sc-block_1-0" class="comp mntl-sc-block mntl-sc-block-html"> To understand the impact of expansionary monetary policy on <a href="https://www.thoughtco.com/economics-4133521" data-component="link" data-source="inlineLink" data-type="internalLink" data-ordinal="1">aggregate demand</a>, let's take a look at a simple example. </p> <div id="mntl-sc-block_2-0" class="comp mntl-sc-block mntl-sc-block-adslot mntl-block"></div> <span class="heading-toc" id="toc-aggregate-demand-and-two-different-countries"></span><h2 id="mntl-sc-block_3-0" class="comp mntl-sc-block reference-sc-block-heading mntl-sc-block-heading"> <span class="mntl-sc-block-heading__text"> Aggregate Demand and Two Different Countries </span> </h2> <p id="mntl-sc-block_4-0" class="comp mntl-sc-block mntl-sc-block-html"> The example starts as follows: In Country A, all wage contracts are indexed to inflation. That is, each month wages are adjusted to reflect increases in the cost of living as reflected in changes in the price level. In Country B, there are no cost-of-living adjustments to wages, but the workforce is completely unionized (unions negotiate 3-year contracts). </p> <div id="mntl-sc-block_5-0" class="comp mntl-sc-block mntl-sc-block-adslot mntl-block"></div> <span class="heading-toc" id="toc-adding-monetary-policy-to-our-aggregate-demand-problem"></span><h2 id="mntl-sc-block_6-0" class="comp mntl-sc-block reference-sc-block-heading mntl-sc-block-heading"> <span class="mntl-sc-block-heading__text"> Adding Monetary Policy to our Aggregate Demand Problem </span> </h2> <p id="mntl-sc-block_7-0" class="comp mntl-sc-block mntl-sc-block-html"> In which country is an expansionary monetary policy likely to have a larger effect on aggregate output? Explain your answer using aggregate supply and aggregate demand curves. </p> <div id="mntl-sc-block_8-0" class="comp mntl-sc-block mntl-sc-block-adslot mntl-block"></div> <span class="heading-toc" id="toc-the-effect-of-the-expansionary-monetary-policy-on-aggregate-demand"></span><h2 id="mntl-sc-block_9-0" class="comp mntl-sc-block reference-sc-block-heading mntl-sc-block-heading"> <span class="mntl-sc-block-heading__text"> The Effect of the Expansionary Monetary Policy on Aggregate Demand </span> </h2> <p id="mntl-sc-block_10-0" class="comp mntl-sc-block mntl-sc-block-html"> When <a data-inlink="bm5W7stnvfZZJXCRzVKYrQ==" href="https://www.thoughtco.com/economics-4133521" data-component="link" data-source="inlineLink" data-type="internalLink" data-ordinal="1">interest rates</a> are cut (which is our <a data-inlink="dK8cAyP53wBqI__9oUTTTg==" href="https://www.thoughtco.com/expansionary-vs-contractionary-monetary-policy-1146303" data-component="link" data-source="inlineLink" data-type="internalLink" data-ordinal="2">expansionary monetary policy</a>), aggregate demand (AD) shifts up due to the rise in investment and consumption. The shift up of AD causes us to move along the aggregate supply (AS) curve, causing a rise in both real GDP and the price level. We need to determine the effects of this rise in AD, the price level, and <a data-inlink="gsNLn7LoGf76lPgxaBVLWQ==" href="https://www.thoughtco.com/intro-to-the-gdp-deflator-1147522" data-component="link" data-source="inlineLink" data-type="internalLink" data-ordinal="3">real GDP</a> (output) in each of our two countries. </p> <div id="mntl-sc-block_11-0" class="comp mntl-sc-block mntl-sc-block-adslot mntl-block"></div> <span class="heading-toc" id="toc-what-happens-to-aggregate-supply-in-country-a"></span><h2 id="mntl-sc-block_12-0" class="comp mntl-sc-block reference-sc-block-heading mntl-sc-block-heading"> <span class="mntl-sc-block-heading__text"> What Happens to Aggregate Supply in Country A? </span> </h2> <p id="mntl-sc-block_13-0" class="comp mntl-sc-block mntl-sc-block-html"> Recall that in Country A "all wage contracts are indexed to inflation. That is, each month wages are adjusted to reflect increases in the cost of living as reflected in changes in the price level." We know that the rise in Aggregate Demand rose the price level. Thus due to the wage indexing, wages must rise as well. A rise in wages will shift the <a data-inlink="WHj5denj4RgKSr40MCVE4A==" href="https://www.thoughtco.com/slope-of-the-short-run-aggregate-supply-curve-1146841" data-component="link" data-source="inlineLink" data-type="internalLink" data-ordinal="1">aggregate supply curve</a> upwards, moving along the aggregate demand curve. This will cause prices to increase further, but real GDP (output) to fall. </p> <div id="mntl-sc-block_14-0" class="comp mntl-sc-block mntl-sc-block-adslot mntl-block"></div> <span class="heading-toc" id="toc-what-happens-to-aggregate-supply-in-country-b"></span><h2 id="mntl-sc-block_15-0" class="comp mntl-sc-block reference-sc-block-heading mntl-sc-block-heading"> <span class="mntl-sc-block-heading__text"> What Happens to Aggregate Supply in Country B? </span> </h2> <p id="mntl-sc-block_16-0" class="comp mntl-sc-block mntl-sc-block-html"> Recall that in Country B "there are no cost-of-living adjustments to wages, but the workforce is completely unionized.Unions negotiate 3-year contracts." Assuming the contract is not up soon, then wages will not adjust when the price level rises from the rise in aggregate demand. Thus we will not have a shift in the aggregate supply curve and prices and real GDP (output) will not be affected. </p> <div id="mntl-sc-block_17-0" class="comp mntl-sc-block mntl-sc-block-adslot mntl-block"></div> <span class="heading-toc" id="toc-the-conclusion"></span><h2 id="mntl-sc-block_18-0" class="comp mntl-sc-block reference-sc-block-heading mntl-sc-block-heading"> <span class="mntl-sc-block-heading__text"> The Conclusion </span> </h2> <p id="mntl-sc-block_19-0" class="comp mntl-sc-block mntl-sc-block-html"> In Country B we will see a larger rise in real output, because the rise in wages in country A will cause an upward shift in aggregate supply, causing the country to lose some of the gains it made from the expansionary monetary policy. There is no such loss in Country B. </p></div> <div id="sources-and-citation_1-0" class="comp sources-and-citation mntl-block"><div id="citation-widget_1-0" class="comp citation-widget js-citation-widget" data-tracking-container="true"> <div class="citation-widget__container js-container"> <button class="citation-widget__button js-button"> <span class="citation-widget__cite-label">Cite this Article </span> <svg class="icon icon-cite citation-widget__icon-cite" > <use xmlns:xlink="http://www.w3.org/1999/xlink" xlink:href="#icon-cite" href="#icon-cite"></use> </svg> </button> <div class="citation-widget__window js-window"> <svg class="icon icon-close citation-widget__icon-close js-icon-close" > <use xmlns:xlink="http://www.w3.org/1999/xlink" xlink:href="#icon-close" href="#icon-close"></use> </svg> <div class="citation-widget__heading">Format</div> <a href="#" class="citation-widget__format-link citation-widget__format-link--active js-format-link">mla</a> <a href="#" class="citation-widget__format-link js-format-link">apa</a> <a href="#" class="citation-widget__format-link js-format-link">chicago</a> <div class="citation-widget__heading">Your Citation</div> <div class="citation-widget__content js-content"> <span class="citation-widget__citation citation-widget__citation--active js-active" data-citation-format="mla">Moffatt, Mike. "Expansionary Monetary Policy and Aggregate Demand." ThoughtCo, Apr. 5, 2023, thoughtco.com/expansionary-monetary-policy-and-aggregate-demand-1146843.</span> <span class="citation-widget__citation" data-citation-format="apa">Moffatt, Mike. (2023, April 5). Expansionary Monetary Policy and Aggregate Demand. Retrieved from https://www.thoughtco.com/expansionary-monetary-policy-and-aggregate-demand-1146843</span> <span class="citation-widget__citation" data-citation-format="chicago">Moffatt, Mike. "Expansionary Monetary Policy and Aggregate Demand." ThoughtCo. https://www.thoughtco.com/expansionary-monetary-policy-and-aggregate-demand-1146843 (accessed February 18, 2025).</span> </div> <div class="citation-widget__copy-container"> <button class="citation-widget__copy-button js-copy-button"> <div class="citation-widget__copy-wrapper"> <svg class="icon icon-checkmark citation-widget__icon-checkmark" > <use xmlns:xlink="http://www.w3.org/1999/xlink" xlink:href="#icon-checkmark" href="#icon-checkmark"></use> </svg> <span class="citation-widget__copy-label js-copy-label">copy citation</span> </div> </button> </div> </div> </div> </div></div></div> </div><div class="loc article-right-rail"><div id="mm-ads-right-rail_1-0" class="comp mm-ads-right-rail mntl-block"><div id="sc-billboard-group_1-0" class="comp sc-billboard-group mntl-block js-scads-inline-content"><div id="mntl-block_2-0" class="comp mntl-block"><div id="ref-billboard1-sticky-dynamic_1-0" class="comp ref-billboard1-sticky-dynamic mntl-block"><div 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style="height: 600px;"><div id="mm-ads-sc-sticky-square-ad_6-0" class="comp mm-ads-sc-sticky-square-ad mm-ads-square mm-ads-gpt-adunit gpt square dynamic"> <div id="square-fixed" class="wrapper" data-type="square" data-pos="atf" data-priority="2" data-sizes="[[300, 250],"fluid"]" data-rtb="true" data-wait-for-third-party="false" data-targeting="{}"></div> </div></div></div></div> <div id="mntl-block_6-0" class="comp mntl-block"><div id="ref-billboard4-sticky-dynamic_1-0" class="comp ref-billboard4-sticky-dynamic mntl-block"><div id="mm-ads-sc-sticky-square-ad_7-0" class="comp mm-ads-sc-sticky-square-ad mm-ads-squareFixed-sticky-dynamic mm-ads-sc-sticky-square scads-to-load right-rail__item" data-height="600" style="height: 600px;"><div id="mm-ads-sc-sticky-square-ad_8-0" class="comp mm-ads-sc-sticky-square-ad mm-ads-square mm-ads-gpt-adunit gpt square dynamic"> <div id="square-fixed" class="wrapper" data-type="square" data-pos="atf" data-priority="2" data-sizes="[[300, 250],"fluid"]" 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id="mm-ads-sc-sticky-square-ad_11-0" class="comp mm-ads-sc-sticky-square-ad mm-ads-squareFixed-sticky-dynamic mm-ads-sc-sticky-square scads-to-load right-rail__item" data-height="600" style="height: 600px;"><div id="mm-ads-sc-sticky-square-ad_12-0" class="comp mm-ads-sc-sticky-square-ad mm-ads-square mm-ads-gpt-adunit gpt square dynamic"> <div id="square-fixed" class="wrapper" data-type="square" data-pos="atf" data-priority="2" data-sizes="[[300, 250],"fluid"]" data-rtb="true" data-wait-for-third-party="false" data-targeting="{}"></div> </div></div></div></div> <div id="mntl-block_9-0" class="comp mntl-block"><div id="ref-billboard7-sticky-dynamic_1-0" class="comp ref-billboard7-sticky-dynamic mntl-block"><div id="mm-ads-sc-sticky-square-ad_13-0" class="comp mm-ads-sc-sticky-square-ad mm-ads-squareFixed-sticky-dynamic mm-ads-sc-sticky-square scads-to-load right-rail__item" data-height="600" style="height: 600px;"><div id="mm-ads-sc-sticky-square-ad_14-0" class="comp mm-ads-sc-sticky-square-ad mm-ads-square mm-ads-gpt-adunit gpt square dynamic"> <div id="square-fixed" class="wrapper" data-type="square" data-pos="atf" data-priority="2" data-sizes="[[300, 250],"fluid"]" data-rtb="true" data-wait-for-third-party="false" data-targeting="{}"></div> </div></div></div></div> <div id="mntl-block_10-0" class="comp mntl-block"></div> <div id="mntl-block_11-0" class="comp mntl-block"></div> <div id="mntl-block_12-0" class="comp mntl-block"></div></div></div> </div></article> <div id="prefooter--outbrain_1-0" class="comp prefooter--outbrain prefooter mntl-block"><div id="reference-outbrain_1-0" class="comp reference-outbrain mntl-outbrain"> <div class="OUTBRAIN js-outbrain-widget" data-src="https://www.thoughtco.com/expansionary-monetary-policy-and-aggregate-demand-1146843" data-widget-id="AR_1"></div> </div> <section id="masonry-list-section_1-0" class="comp masonry-list-section mntl-block" data-tracking-container="true"><ul id="mntl-masonry-tax-card-list_1-0" class="comp mntl-masonry-tax-card-list mntl-masonry-card-list mntl-masonry-list mntl-block masonry-list"><li id="masonry-list__item_1-0" class="comp masonry-list__item mntl-block"><a id="mntl-card_1-0" class="comp mntl-card mntl-document-card is-inverted-small card card--no-image" data-doc-id="1146844" data-tax-levels href="https://www.thoughtco.com/aggregate-demand-and-supply-practice-question-1146844" data-ordinal="1" data-cta="Read Now ▸"> <div class="loc card__top"><div class="card__media mntl-universal-image universal-image__container"><div class="img-placeholder" style="padding-bottom:100.0%;"> <img data-src="https://www.thoughtco.com/thmb/WVXdW8vdPugULG2YhHCnOP2mcng=/250x390/filters:no_upscale():max_bytes(150000):strip_icc()/aggregate1-56a27d773df78cf77276a28f.JPG" width="250" height="390" alt="Aggregate Demand &amp; Supply 1" class="lazyload card__img universal-image__image" data-dim-ratio="1" /> <noscript> <img src="https://www.thoughtco.com/thmb/WVXdW8vdPugULG2YhHCnOP2mcng=/250x390/filters:no_upscale():max_bytes(150000):strip_icc()/aggregate1-56a27d773df78cf77276a28f.JPG" width="250" height="390" class="img--noscript card__img universal-image__image" alt="Aggregate Demand &amp; Supply 1" /> </noscript> </div></div> </div> <div class="card__content " > <div class="card__header" data-kicker="Supply & Demand"></div> <div class="card__title"><span class="card__title-text ">Aggregate Demand & Aggregate Supply Practice Question</span></div> </div> </a></li> <li id="masonry-list__item_2-0" class="comp masonry-list__item mntl-block"><a id="mntl-card_2-0" class="comp mntl-card mntl-document-card is-inverted-small card card--no-image" data-doc-id="1146834" data-tax-levels href="https://www.thoughtco.com/the-slope-of-the-aggregate-demand-curve-1146834" data-ordinal="2" data-cta="Read Now ▸"> <div class="loc card__top"><div class="card__media mntl-universal-image universal-image__container"><div class="img-placeholder" style="padding-bottom:66.6%;"> <img data-src="https://www.thoughtco.com/thmb/aZTFjAbhwZvjN2T2XqSV-49yHmE=/250x1413/filters:no_upscale():max_bytes(150000):strip_icc()/87113248_10-56a27dcb5f9b58b7d0cb44be.jpg" width="250" height="1413" alt="Woman shopping in grocery store" class="lazyload card__img universal-image__image" data-dim-ratio="1.501" /> <noscript> <img src="https://www.thoughtco.com/thmb/aZTFjAbhwZvjN2T2XqSV-49yHmE=/250x1413/filters:no_upscale():max_bytes(150000):strip_icc()/87113248_10-56a27dcb5f9b58b7d0cb44be.jpg" width="250" height="1413" class="img--noscript card__img universal-image__image" alt="Woman shopping in grocery store" /> </noscript> </div></div> </div> <div class="card__content " > <div class="card__header" data-kicker="Supply & Demand"></div> <div class="card__title"><span class="card__title-text ">The Slope of the Aggregate Demand Curve</span></div> </div> </a></li> <li id="masonry-list__item_3-0" class="comp masonry-list__item mntl-block"><a id="mntl-card_3-0" class="comp mntl-card mntl-document-card is-inverted-small card card--no-image" data-doc-id="1146841" data-tax-levels href="https://www.thoughtco.com/slope-of-the-short-run-aggregate-supply-curve-1146841" data-ordinal="3" data-cta="Read Now ▸"> <div class="loc card__top"><div class="card__media mntl-universal-image universal-image__container"><div class="img-placeholder" style="padding-bottom:75.0%;"> <img data-src="https://www.thoughtco.com/thmb/VRJDYezE-l9hnSNiB7LH0ZzvKdg=/250x576/filters:no_upscale():max_bytes(150000):strip_icc()/ascending-line-graph-and-list-of-share-prices-88621476-58d9645e3df78c516240d61f-5a9b51adfa6bcc0037c20f86.jpg" width="250" height="576" alt="Ascending line graph and list of share prices" class="lazyload card__img universal-image__image" data-dim-ratio="1.333" /> <noscript> <img 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