Explain why a reduction in interest rates might lead to an increase in aggregate demand.

Evaluate the view that expansionary monetary policy is the most effective way to achieve economic growth.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definitions of aggregate demand, interest rates
• diagram to show how a reduction in interest rates increases aggregate demand
• explanation that a reduction in interest rates increases consumption and investment, leading to an increase in aggregate demand
• examples of how a reduction in interest rates increases aggregate demand in practice and/or of countries where reduced interest rates have increased aggregate demand.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part B.

Answers may include:

• definitions of monetary policy, economic growth
• diagram to show the effect of expansionary monetary policy on economic growth
• explanation of expansionary monetary policy by reducing interest rates will increase consumption and investment, leading to a rise in aggregate demand and therefore economic growth
• examples of the impact of expansionary monetary policy on economic growth
• synthesis and evaluation.

Evaluation may include: consideration of the problems of expansionary monetary policy, such as inflation, that consumption and investment may not increase if business and consumer confidence are low, and the time lags associated with interest rate changes. Responses could also cover alternative policies to achieve economic growth, such as fiscal policy or supply-side policy.