Question

The term "liquidity trap" describes a macroeconomic scenario in which

low interest rates cause firms to shift toward capital and away from labor, increasing unemployment.

increased levels of imports cause a country to shift away from manufacturing, which leads to increasingly higher levels of imports.

low interest rates cause people to hoard money, making output and employment stagnate.

an excess of cash is introduced into the economy, causing large levels of inflation.

Answer 1

Low interest rates cause people to hoard money, making output and employment stagnate.

The concept of the liquidity trap was first proposed by John Maynard Keynes. He believed that if interest rates were extremely low, people would hoard money in the believe that interest rates could only increase. This results in a stagnation in the level of investment, which would theoretically halt the growth of income and employment. For this reason, Keynes and his proponents maintained that fiscal policy, rather than monetary policy, would be the most effective tool for leaving the great depression.