When the economy is in the liquidity trap, monetary policy is effective and fiscal policy is ineffective.

Question

Quizplus · Accepted Answer

In a liquidity trap, the interest rate is very low and the demand for investment is also very low. In such a scenario, monetary policy becomes ineffective as further reduction in interest rates does not stimulate borrowing and investment. Fiscal policy, on the other hand, can be effective in this situation as government spending can boost aggregate demand and increase economic activity.

When the Economy Is in the Liquidity Trap, Monetary Policy