In the liquidity trap case where the LM schedule is nearly horizontal,
A)both monetary and fiscal policy are highly effective.
B)monetary and fiscal policy are ineffective.
C)monetary policy is ineffective and fiscal policy is effective.
D)fiscal policy is ineffective and monetary policy is effective.

Question

Quizplus · Accepted Answer

In a liquidity trap, the demand for money becomes perfectly elastic due to interest rates being so low that people are indifferent between holding money and bonds. As a result, monetary policy (changing the money supply) has little to no effect on interest rates or investment, making it ineffective. However, fiscal policy (changing government spending or taxes) can still affect the aggregate demand directly, making it effective.

In the Liquidity Trap Case Where the LM Schedule Is