A restrictive (contractionary) monetary policy is designed to shift the aggregate demand (AD) curve in which direction in the short run?

• A. Rightward, because lower interest rates increase consumption and investment spending
• B. Leftward, because higher interest rates reduce consumption and investment spending
• C. It does not shift AD; it only shifts the short-run aggregate supply (SRAS) curve
• D. Upward, because prices rise immediately while real output stays constant

Answer: (B)

Verified step by step guidance

1. Understand that a restrictive (contractionary) monetary policy typically involves the central bank increasing interest rates to reduce inflationary pressures.
2. Recall that aggregate demand (AD) represents the total demand for goods and services in an economy at different price levels, and it is influenced by factors such as consumption, investment, government spending, and net exports.
3. Recognize that higher interest rates make borrowing more expensive, which tends to reduce consumption and investment spending by households and firms.
4. Since consumption and investment are components of aggregate demand, a decrease in these components causes the AD curve to shift to the left.
5. Therefore, in the short run, a restrictive monetary policy shifts the AD curve leftward, reflecting lower overall demand in the economy.