Why is expansionary monetary policy ineffective in the liquidity trap?
What will be an ideal response?
In the liquidity trap, people are willing to hold all of the money that is available because the interest rate or opportunity cost of holding money is very low. If the Fed increases the money supply, the interest rate will not fall. Because there is no change in the interest rate, there is no change in investment and no change in aggregate spending. As a result, expansionary monetary policy does not increase the level of output. As such, at low interest rates, monetary policy cannot affect interest rates, business investment, and consumer spending through financing and therefore can't affect aggregate demand or unemployment levels. Thus monetary policy at low interest can become ineffectual.
You might also like to view...
If a country's national government wants to stimulate spending in the economy, it should:
A) decrease taxes and increase government spending. B) increase taxes and decrease government spending. C) increase taxes and government spending. D) decrease taxes and government spending.
During the 1960s and early 1970s, economists believed that the Phillips curve indicated
a. that higher inflation was the price for more unemployment. b. that higher levels of employment could be achieved with lower inflation. c. a menu of choices for policy makers. d. All of the above are correct.