Question

"Expansionary monetary policy becomes particularly important if the economy is in a liquidity trap"
Is this statement correct? Explain your answer.

Answer 1

Answer:- The above statement is not correct.

In a liquidity trap situation in which the interest rates are low thus despite lowering the interest rates further, people just don't invest in bonds and saves more in the cash expecting that the interest rates could rise soon. In this situation there are several ways to get out of this situation like raising the interest rate, waiting for the situation till prices falls till some expected level or increase in some government spending. Also monetary policy becomes ineffective as the policymaker tries to influence the nominal interest rates by changing nominal money supply which is block by the private players to accept the money at current interest rate.