Through what mechanism does monetary policy influence Aggregate Demand?

Monetary policy primarily influences Aggregate Demand through the mechanism of adjusting interest rates. When a central bank, such as the Reserve Bank, changes interest rates, it affects borrowing costs for consumers and businesses. A reduction in interest rates lowers the cost of loans, encouraging households to take out mortgages or personal loans and prompting businesses to invest in capital projects. This increased spending from both sectors contributes to a rise in Aggregate Demand.

Conversely, higher interest rates would typically make borrowing more costly, leading to reduced consumer spending and lower business investments. Thus, the adjustment of interest rates enables the central bank to either stimulate or restrain economic activity, which in turn influences overall Demand in the economy.

The other options, while relevant to macroeconomic dynamics, do not facilitate the same direct and immediate relationship with Aggregate Demand as interest rates do in the area of monetary policy. For example, government spending and taxation changes are typically associated with fiscal policy measures rather than monetary policy, while regulating trade balances involves trade policy rather than monetary measures implemented by a central bank.