Which of the following is true of an economy in a liquity trap?
A)The money supply in the economy increases rapidly as additions are made to the monetary base.
B)The economy's nominal short-term interest rates become close to zero.
C)The banks in the economy do not hold any reserves.
D)The economy's interest rates decline when there is an increase in the monetary base.

Question

Quizplus · Accepted Answer

In a liquidity trap, the economy's short-term nominal interest rates become close to zero, making monetary policy ineffective in stimulating economic growth. Option A is incorrect because an increase in the monetary base does not lead to a proportional increase in the money supply in a liquidity trap as banks hoard excess reserves. Option C is incorrect because banks still hold reserves, but they do not lend them out. Option D is incorrect because the interest rates do not decline when there is an increase in the monetary base but remain close to zero.

Which of the Following Is True of an Economy in a Liquity