A liquidity trap occurs when the Federal Reserve reduces reserves in the system, choking off aggregate demand.

Question

Quizplus · Accepted Answer

A liquidity trap occurs when interest rates are already very low and the demand for money becomes inelastic, meaning that even if the central bank injects more money into the system, it will not lead to an increase in spending and aggregate demand. This can happen when people and businesses are more concerned about saving than investing or consuming, and it can lead to a situation where monetary policy loses traction and fiscal policy may be needed to stimulate the economy.

A Liquidity Trap Occurs When the Federal Reserve Reduces Reserves