Discussion
Liquidity trap is a situation when
Answer: A
A liquidity trap is a situation in which all potential investors expect the rate of interest to rise in future. At a very low interest rate bond prices are high and are expected to fall, so everyone prefers to hold money, and any extra money supply is simply absorbed into idle balances without lowering the interest rate further. Option B is wrong because an expected fall in the rate would make people buy bonds, not hoard money. Option C mixes up the natural rate with the Keynesian critical rate. Option D is wrong because in a liquidity trap the speculative demand for money is perfectly interest elastic, not inelastic.
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