Macroeconomics

How Monetary and Fiscal Policies Shift the Aggregate Demand Curve

Panel (a)

shows a monetary expansion. For any given price level, an increase in the money supply

raises real money balances, shifts the LM curve downward, and raises income. Hence,

an increase in the money supply shifts the aggregate demand curve to the right. Panel

(b) shows a fiscal expansion, such as an increase in government purchases or a decrease

in taxes. The fiscal expansion shifts the IS curve to the right and, for any given price level,

raises income. Hence, a fiscal expansion shifts the aggregate demand curve to the right.