What is the key role of monetary policy in influencing aggregate demand?

Monetary policy plays a crucial role in influencing aggregate demand primarily through affecting interest rates and the money supply. When a central bank adjusts interest rates, it directly impacts borrowing costs. Lower interest rates make loans more affordable, encouraging consumers and businesses to spend and invest more. This increase in spending contributes to higher aggregate demand. Conversely, raising interest rates can dampen borrowing and spending, leading to a decrease in aggregate demand.

In terms of the money supply, when the central bank implements policies to increase the amount of money circulating in the economy, it can stimulate economic activity by providing more liquidity for consumers and businesses. When people have access to more money, they are more likely to make purchases, which in turn boosts aggregate demand.

While adjusting tax rates is a tool of fiscal policy and controlling inflation may be an objective of both monetary and fiscal policies, these actions do not primarily influence aggregate demand in the manner that changes in interest rates and money supply do. Additionally, regulating the stock market is not a direct function of monetary policy in terms of aggregate demand but rather pertains to market stability and investor confidence.