When the Federal Reserve uses monetary policy to increase the money supply, it typically does so by lowering interest rates or purchasing government securities. An increase in the money supply can lead to lower borrowing costs for consumers and businesses, making it cheaper for individuals to take out loans for large purchases such as homes and cars, and for businesses to invest in new projects or expand operations.
As people and businesses spend more due to easier access to credit, overall consumer spending rises. Aggregate demand, which is the total demand for goods and services in an economy at a given overall price level and during a specified time period, therefore increases. The additional spending from the increased money supply stimulates economic activity, leading to higher production, employment, and income levels, further enhancing demand.
In summary, a monetary policy that increases the money supply directly encourages higher spending in the economy, resulting in an increase in aggregate demand. This is a fundamental concept in macroeconomic theory, illustrating how central bank actions can influence economic conditions.