When an economy is in a liquidity trap
A) monetary policy cannot be used to influence the exchange rate.
B) monetary policy can be used to drive interest rates down, but not to drive them up.
C) there is an excess demand for bonds.
D) people and institutions avoid holding cash balances.
E) it can escape only by introducing a hard, or illiquid, currency.

Question

Quizplus · Accepted Answer

In a liquidity trap, the interest rates are already near zero, making traditional monetary policy ineffective in influencing the economy, including the exchange rate. People prefer holding cash or very liquid assets over bonds or other investments, due to the expectation that interest rates cannot go much lower and might increase, which would decrease the price of bonds.

When an Economy Is in a Liquidity Trap