Question

Liquidity trap refers to ____________.

• A. shortage of liquidity in the economy
• B. situation when interest rate is so low that people prefer to hold money rather than invest it.
• C. RBI's policy to control interest rates through change in liquidity
• D. situation in business cycle when economy is trapped due to low aggregate demand

Answer 1

Answer: (B)

situation when interest rate is so low that people prefer to hold money rather than invest it.

Liquidity trap is a situation when interest rate is so low that people prefer to hold money rather than invest it. It is the extreme effect of monetary policy. Consumers choose to avoid bonds and keep their funds in savings because of the prevailing belief that interest rates will soon rise.