If an economy finds itself in a liquidity trap:

Question

Quizplus · Accepted Answer

In a liquidity trap, conventional monetary policy becomes ineffective as nominal interest rates approach zero. This is because there is an abundance of liquidity in the economy, but consumers and businesses are not borrowing or spending due to uncertainty about the future. Therefore, the economy is "trapped" by the inability of monetary policy to stimulate spending further through lower interest rates. Option A and D are incorrect because a liquidity trap is characterized by low spending and interest rates approaching zero. Option C is incorrect because there may be some disequilibrium in money markets, but that is not the defining characteristic of a liquidity trap.

If an Economy Finds Itself in a Liquidity Trap