Multiple choice

The 'liquidity trap' shows that

  1. interest rate will fall further

  2. interest rate cannot fall further

  3. interest rate must rise and bond prices fall

  4. interest rate must fall and bond prices rise
Reveal answer Fill a bubble to check yourself
B Correct answer
Explanation

A liquidity trap occurs when nominal interest rates are so low that monetary policy becomes ineffective because people prefer holding cash rather than bonds, meaning interest rates cannot fall any further.

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