Liquidity Trap
A liquidity trap occurs when people prefer holding cash over investing or spending it, even when interest rates are low or zero. In this situation, monetary policy becomes ineffective because lowering interest rates doesn't encourage borrowing or spending. As a result, the economy can stagnate, as businesses struggle to grow and consumers save rather than spend. This phenomenon can hinder economic recovery, particularly during recessions, because the usual tools for stimulating growth—like reducing interest rates—lose their impact when people simply choose to keep their money instead of putting it to work.
Additional Insights
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A liquidity trap occurs when people hoard cash instead of spending or investing it, even when interest rates are very low. In this situation, monetary policy becomes ineffective because even if a central bank lowers interest rates to stimulate the economy, people choose to keep their money rather than borrow and spend. This can lead to stagnation, as demand remains low and economic growth slows. Essentially, it's a paradox where cash is plentiful, but it doesn't lead to economic activity, making it hard for the economy to recover from a downturn.