<blockquote>
<p>isnt contractionary monetary policy a result of inflation?</p>
</blockquote>
<p>Not necessarily, you are assuming central bank that has some price stability mandate. In principle central bank could pursue expansionary monetary policy even when inflation is high and contractionary policy even when inflation is low.</p>
<p>You are presumably working on some self-study question. If the question does not state that central bank responds to inflation, you cannot assume that it does just because many modern western central banks do so. Moreover, if you are working on a self-study question you should not make up your own backstory for the question. If the question starts from some stable equilibrium then there would not be any inflation.</p>
<blockquote>
<p>So, when interest rises, borrowing credit becomes more expensive so people borrow less resulting in AD decreases which explains why there is a negative relationship between price level and GDP?</p>
</blockquote>
<p>That is only one of the reasons. Other important reasons are that it creates negative wealth effect, it reduces investment, and another reason, which exists only in open economy, is that it affects net exports.</p>
<blockquote>
<p>if it is triggered by a change in price level why are we shifting the AD curve?</p>
</blockquote>
<p>We are shifting AD curve because as a result there will be less aggregate demand (e.g. less consumer spending or investment) at any price level. This would by the way hold even if central bank would respond to increase in price level, regardless whether the original change in price level was due to movement along or shift of AD.  This is because in the IS-LM model, movement of the LM curve to the left (i.e. contractionary monetary policy) creates the above described effect where people are now willing to buy less at any price level, so AD shifts.</p>

CC BY-SA 4.0
2024-01-25T22:34:59.620Z
2024-01-25T22:34:59.620Z
1muflon1
<p>i dont understand how the reason that i've stated below causes a shift of the AD curve while the other causes a movement along when they're almost the same thing.
how does contractionary monetary policy cause a shift of the AD curve when the fact that when price level increases goods become less affordable and people take out more credit so when demand for credit rises interest rises as interest is the price of credit. So, when interest rises, borrowing credit becomes more expensive so people borrow less resulting in AD decreases which explains why there is a negative relationship between price level and GDP? isnt contractionary monetary policy a result of inflation? if it is triggered by a change in price level why are we shifting the AD curve?</p>

<monetary-policy><aggregate-demand>
movements along and shifts of the AD curve
anon
# movements along and shifts of the AD curve

(Asked by: username_0 on 2024-01-25)

i dont understand how the reason that i've stated below causes a shift of the AD curve while the other causes a movement along when they're almost the same thing.
how does contractionary monetary policy cause a shift of the AD curve when the fact that when price level increases goods become less affordable and people take out more credit so when demand for credit rises interest rises as interest is the price of credit. So, when interest rises, borrowing credit becomes more expensive so people borrow less resulting in AD decreases which explains why there is a negative relationship between price level and GDP? isnt contractionary monetary policy a result of inflation? if it is triggered by a change in price level why are we shifting the AD curve?

**Tags:** monetary-policy, aggregate-demand

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## 1 answers

### Answer by username_1 on 2024-01-25. Score: 0

> isnt contractionary monetary policy a result of inflation?

Not necessarily, you are assuming central bank that has some price stability mandate. In principle central bank could pursue expansionary monetary policy even when inflation is high and contractionary policy even when inflation is low.

You are presumably working on some self-study question. If the question does not state that central bank responds to inflation, you cannot assume that it does just because many modern western central banks do so. Moreover, if you are working on a self-study question you should not make up your own backstory for the question. If the question starts from some stable equilibrium then there would not be any inflation.

> So, when interest rises, borrowing credit becomes more expensive so people borrow less resulting in AD decreases which explains why there is a negative relationship between price level and GDP?

That is only one of the reasons. Other important reasons are that it creates negative wealth effect, it reduces investment, and another reason, which exists only in open economy, is that it affects net exports.

> if it is triggered by a change in price level why are we shifting the AD curve?

We are shifting AD curve because as a result there will be less aggregate demand (e.g. less consumer spending or investment) at any price level. This would by the way hold even if central bank would respond to increase in price level, regardless whether the original change in price level was due to movement along or shift of AD. This is because in the IS-LM model, movement of the LM curve to the left (i.e. contractionary monetary policy) creates the above described effect where people are now willing to buy less at any price level, so AD shifts.


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