What is a liquidity trap?

Under normal circumstances, when there is an increase in the money supply the interest rate should decrase because money is more abundant hence the cost of borrowing is low. In a liquidity trap the interest rate is so low that cannot decrease further, even if there is an increase in the money supply. When a nation is in a liquidity trap, hyperinflation can occur as the demand for money is perfectly elastic like it happened in Germany with the Deutschmark. Liquidity traps usually happen during adverse conditions for example crises and wars. Fiscal policies like government spending and tax cuts can increase output during a liquidity trap but without recovering from that position.

ML
Answered by Maria L. Economics tutor

4375 Views

See similar Economics GCSE tutors

Related Economics GCSE answers

All answers ▸

Explain one consequence of a more globalised world?


Why might the Bank of England raise the bank rate if inflation rises above 2%?


Explain how a fall in interest rates can affect total spending in the economy.


What are the factors that could affect the exchange rate?


We're here to help

contact us iconContact ustelephone icon+44 (0) 203 773 6020
Facebook logoInstagram logoLinkedIn logo

MyTutor is part of the IXL family of brands:

© 2026 by IXL Learning