Final answer:
The impact on aggregate demand is larger when the Fed maintains a fixed interest rate instead of holding the money supply constant following an increase in government spending. Fixed interest rates stimulate demand more than a constant money supply. However, increasing the money supply can raise GDP and lower unemployment temporarily but may result in higher inflation over time.
Step-by-step explanation:
If government spending increases, the effect on aggregate demand would be larger if the Federal Reserve (Fed) committed to maintaining a fixed interest rate rather than holding the money supply constant. This is because fixed interest rates tend to stimulate consumption and investment demand more vigorously. When the Fed fixes the interest rate, it typically must adjust the money supply to maintain that rate, which can lead to more pronounced changes in economic activity.
In contrast, if the Fed holds the money supply constant, interest rates might rise as a result of the increased demand for funds, which could dampen the stimulative effect of government spending on aggregate demand.
Additionally, if the Fed increases the supply of money at an increasing rate, the likely impacts would include an increase in GDP and a decrease in unemployment in the short run. However, over time, this could also lead to higher inflation rates.