What is a liquidity trap?
A)A situation in which banks stop lending to one another.
B)A situation in which further increases in the money supply result in smaller reductions in the interest rate until the interest rate approaches zero.
C)A situation in which the Fed no longer has the capacity to provide liquidity to the system.
D)A situation in which the interest rate gets so high that consumers and companies no longer can afford to obtain credit.
E)None of these.

Question

Quizplus · Accepted Answer

A liquidity trap occurs when interest rates are already very low, and increasing the money supply no longer leads to significant reductions in interest rates. This makes monetary policy ineffective in stimulating economic growth and increasing investment. In a liquidity trap, the economy remains stagnant despite the efforts of central banks to increase the money supply.

What Is a Liquidity Trap