The liquidity trap exists because the lower portion of the money demand curve is horizontal.

Question

Quizplus · Accepted Answer

In a liquidity trap, the central bank cannot stimulate the economy through monetary policy because people prefer to hold cash instead of investing it, and the lower portion of the money demand curve becomes horizontal. This means that even if interest rates are reduced to zero, people will not increase their investment and consumption, and instead, they will continue to hold cash. Therefore, the correct statement is that the liquidity trap exists because the lower portion of the money demand curve is horizontal.

The Liquidity Trap Exists Because the Lower Portion of the Money