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

4050 Views

See similar Economics GCSE tutors

Related Economics GCSE answers

All answers ▸

What is an opportunity cost?


Bill's Diner is an American burger restaurant. There is an increase in import costs of products needed from America, and change in perceptions of fast food such as burgers, due to an increase in health warnings. Discuss the effects on the market. (6)


Should skilled workers be paid more than unskilled workers? (8 marks)


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


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:

© 2025 by IXL Learning