When does the liquidity trap happen?

When does the liquidity trap happen?

When does the liquidity trap happen?



Factors favouring the liquidity trap

The liquidity trap is created in context of low interest rates, high savings rates and with a monetary policy that try to stimulate the economy.


Step 1: The central bank injects cash into private banks
The goal of the central bank is to stimulate the economy

Step 2: The injection is ineffective
The injection has no effect on interest rates or on the level of income
People keep their cash either because they believe that interest rates will soon rise or because they do not want to hold an asset which has an expected price decline.

Step 3: This results in
An ineffective monetary policy that didn’t stimulate the economy.
An situation which is worse then before: interest rates are now close to zero, the state has injected money for nothing, the money injected may create bubbles in the near future and the state has placed itself in debt.



View More On This Topics
http://www.investopedia.com/terms/l/liquiditytrap.asp
http://economictimes.indiatimes.com/definition/liquidity-trap
https://www.stlouisfed.org/publications/regional-economist/april-2014/the-liquidity-trap-an-alternative-explanation-for-todays-low-inflation
http://en.wikipedia.org/wiki/Liquidity_trap
http://en.wikipedia.org/wiki/File:Liquidity_trap_IS-LM.svg