Economics • Economic BasicsMedium
What is the primary implication of the 'Liquidity Trap' in Keynesian macroeconomic theory?
A. Monetary policy becomes highly effective in stimulating investment.
B. Interest rates fall to zero, and further injections of money supply fail to lower interest rates or stimulate economic activity.✓ Correct Answer
C. Fiscal policy becomes completely ineffective due to crowding out.
D. Inflation rises uncontrollably due to excess money supply.
💡 Solution & Explanation
A liquidity trap arises when nominal interest rates decline close to zero and the public prefers holding liquid cash rather than investing in bonds. Under this condition, further expansion of the money supply by the central bank fails to lower interest rates further or boost economic activity, rendering conventional monetary policy impotent. This concept is a core element of Keynesian macroeconomics.
More Economics Economic Basics questions
- What does 'Liquidity Trap' refer to in monetary economics?
- What does the 'Multiplier Effect' in Keynesian economics signify?
- In macroeconomic theory, what does 'Ricardian Equivalence' suggest about the financing of government…
- What is represented by the 'Phillips Curve' in macroeconomics?
- Analyze the implications of the Lucas Critique for macroeconomic policy evaluation. What is the core argument…