Growth and Indicators

Economic Affairs

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Indian Economy - Understanding the basics of Indian economic system

In an economy a situation of liquidity trap is characterised by which of the following?

1. Low savings rate

2. High demand for bonds

3. Expansionary monetary policy

Select the correct answer using the code given below.

1 and 2 only

2 and 3 only

3 only

1, 2 and 3

Liquidity trap is a situation when expansionary monetary policy (increase in money supply) does not increase the interest rate, income and hence does not stimulate economic growth.
It is the situation in which prevailing interest rates are low and savings rates are high, making monetary policy ineffective.
In a liquidity trap, consumers choose to avoid bonds and keep their funds in savings, because of the prevailing belief that interest rates will soon rise. Because bonds have an inverse relationship to interest rates, many consumers do not want to hold an asset with a price that is expected to decline.