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Discuss the possible limitation of easy Monetary policy under Liquidity Trap in Keynesian Transmission Mechanism(1 point)

Discuss the possible limitation of easy Monetary policy under Liquidity Trap in Keynesian Transmission Mechanism(1 point)

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to understand the limitation of easy monetary policy it is necessary to first understand what is ease monetary policy and its objective .Under easy monetary policy central bank infuse money in the economy at a low interest rate .The objective of this is stimulate investment and generate demand .

Under Liquidity trap an increase in the money supply does not leads to fall in the interest rate but leads to an addition to idle cash balances. Under this situation the liquidity preference curve becomes completely elastic and horizontal and result of it is if central bank tries to increase investment by increasing money supply, it will fail in its objective interest rate will not fall further, because an increase in the money supply created in order to bring down the rate of interest would be held in the form of cash balances.

The following diagram shows liquidity trap

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