Draw the graph · Macro · Aggregate demand and aggregate supply
The central bank raises rates
Drag a curve sideways, or use its arrows. A curve you do not move is a curve you are saying stays put. Make each shift clear enough that a reader could see it.
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Aggregate demand shifts left. Short-run aggregate supply stays put. Long-run aggregate supply stays put.
Higher interest rates make borrowing costlier, so households buy fewer big-ticket items and firms invest less. Consumption and investment fall at every price level, so AD shifts left. Supply curves do not move. Output falls back toward potential.
The price level falls and real GDP falls, closing the inflationary gap.
Common mistake. Students sometimes shift SRAS left because 'borrowing costs are a cost for firms.' The dominant channel is spending: less investment and less consumption. That is demand.
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Lesson: Monetary Policy Transmission