If we were in a liquidity trap,
A)investment would be totally interest insensitive
B) fiscal expansion would be unlikely to drive interest rates up
C) monetary policy would be more powerful than fiscal policy
D)an increase in government spending would be totally offset by a decrease in private investment
E)crowding out would be made worse by the inability of monetary policy to accommodate fiscal policy

Question

Quizplus · Accepted Answer

In a liquidity trap, interest rates are already at or near zero, so fiscal expansion would be unlikely to drive them up. A is incorrect because investment may still be somewhat interest sensitive in a liquidity trap. C is incorrect because monetary policy is typically constrained in a liquidity trap, as interest rates cannot be lowered any further. D is incorrect because an increase in government spending could potentially increase aggregate demand even if private investment falls. E is incorrect because crowding out could still occur, but it may be less severe if monetary policy cannot push interest rates up.

If We Were in a Liquidity Trap