Economics • Economic BasicsMedium
What is meant by 'Liquidity Trap' in macroeconomic theory?
A. A situation where commercial banks refuse to lend money to any sector
B. A condition where nominal interest rates are so low that monetary policy becomes ineffective as people hoard cash✓ Correct Answer
C. A state where foreign exchange reserves are completely depleted
D. A regulatory measure preventing banks from holding liquid assets
💡 Solution & Explanation
A liquidity trap arises when monetary policy fails because nominal interest rates are pushed to near zero, causing individuals and institutions to hoard cash rather than invest due to expectations of future economic stagnation. This condition renders conventional central bank rate cuts ineffective in boosting economic demand. Alternative measures like fiscal stimulus or quantitative easing are then required to revive growth.
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