Consider the following statements about lsquo Liquidity Trap rsquo 1 The liquidity trap is the situa...........

Economic Affairs Financial Markets

Consider the following statements about ‘Liquidity Trap’:

1.The liquidity trap is the situation in which prevailing interest rates are low and savings rates are high.

2.It occurs when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.

3.During the situation of liquidity trap monetary policy becomes ineffective.

Which of above statements are correct?

1 and 2 only

2 and 3 only

1and 3 only

All of the above

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Explanation:

- Statement 1: A liquidity trap involves low interest rates and high savings rates, which disincentivize investment and spending.

- Statement 2: People may start hoarding cash in anticipation of negative events like deflation or insufficient demand, contributing to the liquidity trap.

- Statement 3: In a liquidity trap, monetary policy, specifically lowering interest rates, becomes ineffective because people prefer to hold onto cash rather than spend or invest it.

- Option 1: Only statements 1 and 2. Lacks statement 3, which is necessary for completeness.

- Option 2: Only statements 2 and 3. Lacks the context of statement 1.

- Option 3: Only statements 1 and 3. Misses the explanation about why the trap occurs (statement 2).

- Option 4: All of the above statements (1, 2, and 3) are correct and provide a comprehensive explanation of a liquidity trap.