A liquidity trap occurs when:
A) banks have too much currency and close their doors to new customers.
B) the central bank mistakenly prints too much money, generating hyperinflation.
C) interest rates fall so low that monetary policy is no longer effective.
D) dams and locks are built to prevent flooding.

Question

Quizplus · Accepted Answer

A liquidity trap occurs when interest rates fall so low that monetary policy is no longer effective. When interest rates are already near zero, further decreases will not stimulate borrowing and investment. This is because people and businesses may hold onto their money instead of lending or investing it, in hopes of even lower interest rates in the future. This stagnant economic activity can lead to deflation and a lack of economic growth.

A Liquidity Trap Occurs When