ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -A liquidity trap occurs when interest rates are very low, yet consumers prefer to hoard cash rather than spend or invest their money in higher-yielding bonds or other investments. In such cases, the main tool used by the central bank has failed to be effective.

Detailed explanation-2: -A liquidity trap can occur when consumers and investors hoard cash and refuse to spend even when economic policymakers cut interest rates to stimulate economic growth. Expansionary policy is a macroeconomic policy that seeks to boost aggregate demand to stimulate economic growth.

Detailed explanation-3: -Usually, a decrease in interest rates encourages spending, but in a liquidity trap, the change in the money supply does not change spending habits. Therefore the use of monetary policy is ineffective (as seen above).

Detailed explanation-4: -Definition: Liquidity trap is a situation when expansionary monetary policy (increase in money supply) does not increase the interest rate, income and hence does not stimulate economic growth. Description: Liquidity trap is the extreme effect of monetary policy.

Detailed explanation-5: -A liquidity trap is an economic situation where people hoard financial capital instead of investing or spending it as the interest rates are low and savings rates are high which renders monetary policy ineffective.