The liquidity trap refers to the situation where
A) the Fed adds excess reserves to the banking system, but it has minimal positive effect on lending, investment, or aggregate demand.
B) excessive consumer debt limits the growth in consumer spending necessary to bring the economy out of recession.
C) the public debt is so large that federal borrowing drives up interest rates and discourages private sector spending.
D) a ﬁnancial crisis causes a run on banks and the elimination of billions in excess reserves.

Question

Quizplus · Accepted Answer

In a liquidity trap, interest rates are already low and therefore monetary policy becomes ineffective at stimulating the economy. Despite the central bank injecting excess reserves into the banking system, there is little to no increase in lending, investment, or aggregate demand.

The Liquidity Trap Refers to the Situation Where