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Which of the following characterize a situation of a 'liquidity trap' in an economy?
1. Decline in bond prices
2. Lower interest rates
3. High savings rates
Select the correct answer using the code given below.
- a)1 and 2 only
- b)2 and 3 only
- c)1 and 3 only
- d)1, 2 and 3
Correct answer is option 'D'. Can you explain this answer?
Most Upvoted Answer
Which of the following characterize a situation of a liquidity trap in...
A liquidity trap occurs when the central bank's efforts to stimulate the economy by lowering interest rates are ineffective. In such a situation, the economy is stuck in a state of low growth or recession, with little or no impact from conventional monetary policy measures. The following factors characterize a liquidity trap:
1. Decline in bond prices: In a liquidity trap, the demand for bonds decreases, resulting in a decline in bond prices. This happens because investors are more inclined to hold cash rather than invest in bonds or other financial assets due to the prevailing pessimistic economic conditions. As a result, the prices of bonds fall, and their yields (interest rates) rise.
2. Lower interest rates: Despite the central bank's efforts to reduce interest rates to stimulate borrowing and investment, interest rates remain low or even reach zero. This occurs because in a liquidity trap, the demand for credit is weak, and businesses and individuals are reluctant to take on additional debt, even at low interest rates. Consequently, lowering interest rates fails to stimulate borrowing and investment as intended.
3. High savings rates: In a liquidity trap, individuals and businesses tend to save more rather than spend or invest. This increased propensity to save is driven by uncertainty and pessimism about the economic outlook. High savings rates further exacerbate the situation by reducing consumption and investment, leading to a decline in aggregate demand.
In a liquidity trap, the combination of declining bond prices, persistently low interest rates, and high savings rates creates a scenario where monetary policy loses its effectiveness in stimulating economic growth. The conventional tools used by central banks, such as reducing interest rates, are insufficient to encourage borrowing and investment, as individuals and businesses prefer to hold onto cash rather than spend or invest.
Overall, a liquidity trap represents a challenging economic situation where unconventional measures, such as fiscal stimulus or unconventional monetary policies like quantitative easing, may need to be employed to break the cycle of low growth and deflationary pressures.
1. Decline in bond prices: In a liquidity trap, the demand for bonds decreases, resulting in a decline in bond prices. This happens because investors are more inclined to hold cash rather than invest in bonds or other financial assets due to the prevailing pessimistic economic conditions. As a result, the prices of bonds fall, and their yields (interest rates) rise.
2. Lower interest rates: Despite the central bank's efforts to reduce interest rates to stimulate borrowing and investment, interest rates remain low or even reach zero. This occurs because in a liquidity trap, the demand for credit is weak, and businesses and individuals are reluctant to take on additional debt, even at low interest rates. Consequently, lowering interest rates fails to stimulate borrowing and investment as intended.
3. High savings rates: In a liquidity trap, individuals and businesses tend to save more rather than spend or invest. This increased propensity to save is driven by uncertainty and pessimism about the economic outlook. High savings rates further exacerbate the situation by reducing consumption and investment, leading to a decline in aggregate demand.
In a liquidity trap, the combination of declining bond prices, persistently low interest rates, and high savings rates creates a scenario where monetary policy loses its effectiveness in stimulating economic growth. The conventional tools used by central banks, such as reducing interest rates, are insufficient to encourage borrowing and investment, as individuals and businesses prefer to hold onto cash rather than spend or invest.
Overall, a liquidity trap represents a challenging economic situation where unconventional measures, such as fiscal stimulus or unconventional monetary policies like quantitative easing, may need to be employed to break the cycle of low growth and deflationary pressures.
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Which of the following characterize a situation of a liquidity trap in an economy?1. Decline in bond prices2. Lower interest rates3. High savings ratesSelect the correct answer using the code given below.a)1 and 2 onlyb)2 and 3 onlyc)1 and 3 onlyd)1, 2 and 3Correct answer is option 'D'. Can you explain this answer?
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Which of the following characterize a situation of a liquidity trap in an economy?1. Decline in bond prices2. Lower interest rates3. High savings ratesSelect the correct answer using the code given below.a)1 and 2 onlyb)2 and 3 onlyc)1 and 3 onlyd)1, 2 and 3Correct answer is option 'D'. Can you explain this answer? for UPSC 2025 is part of UPSC preparation. The Question and answers have been prepared according to the UPSC exam syllabus. Information about Which of the following characterize a situation of a liquidity trap in an economy?1. Decline in bond prices2. Lower interest rates3. High savings ratesSelect the correct answer using the code given below.a)1 and 2 onlyb)2 and 3 onlyc)1 and 3 onlyd)1, 2 and 3Correct answer is option 'D'. Can you explain this answer? covers all topics & solutions for UPSC 2025 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for Which of the following characterize a situation of a liquidity trap in an economy?1. Decline in bond prices2. Lower interest rates3. High savings ratesSelect the correct answer using the code given below.a)1 and 2 onlyb)2 and 3 onlyc)1 and 3 onlyd)1, 2 and 3Correct answer is option 'D'. Can you explain this answer?.
Which of the following characterize a situation of a liquidity trap in an economy?1. Decline in bond prices2. Lower interest rates3. High savings ratesSelect the correct answer using the code given below.a)1 and 2 onlyb)2 and 3 onlyc)1 and 3 onlyd)1, 2 and 3Correct answer is option 'D'. Can you explain this answer? for UPSC 2025 is part of UPSC preparation. The Question and answers have been prepared according to the UPSC exam syllabus. Information about Which of the following characterize a situation of a liquidity trap in an economy?1. Decline in bond prices2. Lower interest rates3. High savings ratesSelect the correct answer using the code given below.a)1 and 2 onlyb)2 and 3 onlyc)1 and 3 onlyd)1, 2 and 3Correct answer is option 'D'. Can you explain this answer? covers all topics & solutions for UPSC 2025 Exam. Find important definitions, questions, meanings, examples, exercises and tests below for Which of the following characterize a situation of a liquidity trap in an economy?1. Decline in bond prices2. Lower interest rates3. High savings ratesSelect the correct answer using the code given below.a)1 and 2 onlyb)2 and 3 onlyc)1 and 3 onlyd)1, 2 and 3Correct answer is option 'D'. Can you explain this answer?.
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