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Which of the following characterise a situation of a 'liquidity trap' in an economy?
- Decline in bond prices
- Lower interest rates
- 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 characterise a situation of a liquidity trap in...
- A liquidity trap is a contradictory economic situation in which interest rates are very low and savings rates are high, rendering monetary policy ineffective. Hence options 2 and 3 are correct.
- It was first described by economist John Maynard Keynes.
- During a liquidity trap, consumers choose to avoid bonds and keep their funds in cash savings because of the prevailing belief that interest rates could soon rise (which would push bond prices down and yields up). 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. Hence option 1 is correct.
- At the same time, central bank efforts to spur economic activity are hampered as they are unable to lower interest rates further to incentivize investors and consumers.
- While a liquidity trap is a function of economic conditions, it is also psychological since consumers are making a choice to hoard cash instead of choosing higher-paying investments because of a negative economic view.
- A liquidity trap is not limited to bonds. It also affects other areas of the economy, as consumers are spending less on products which means businesses are less likely to hire.
- Some ways to get out of a liquidity trap include raising interest rates, hoping the situation will regulate itself as prices fall to attractive levels, or increased government spending.
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Which of the following characterise a situation of a liquidity trap in...
A liquidity trap is a situation in which conventional monetary policy tools become ineffective in stimulating economic growth and reducing deflationary pressures. In a liquidity trap, lower interest rates, high savings rates, and a decline in bond prices are all characteristics that can be observed.
Decline in bond prices:
- In a liquidity trap, there is a decline in bond prices. This occurs because when interest rates are already near zero, investors have limited options for returns on their investments. As a result, they may sell bonds, causing their prices to decline. This decline in bond prices can further exacerbate deflationary pressures in the economy.
Lower interest rates:
- Lower interest rates are a characteristic of a liquidity trap. In a liquidity trap, the central bank reduces interest rates to stimulate borrowing and investment in the economy. However, when interest rates are already near zero, further reductions have limited impact on stimulating economic activity. This is because individuals and businesses may be hesitant to borrow and invest even at very low interest rates due to uncertainties about the future and lack of confidence in the economy.
High savings rates:
- High savings rates are also a characteristic of a liquidity trap. In a liquidity trap, individuals and businesses tend to save more and spend less. This is because they may be uncertain about the future and prefer to hold onto their money rather than spending or investing it. High savings rates can further contribute to a decline in aggregate demand and economic stagnation.
In summary, a liquidity trap is characterized by a decline in bond prices, lower interest rates, and high savings rates. These factors contribute to a lack of effective monetary policy tools to stimulate economic growth and combat deflationary pressures.
Decline in bond prices:
- In a liquidity trap, there is a decline in bond prices. This occurs because when interest rates are already near zero, investors have limited options for returns on their investments. As a result, they may sell bonds, causing their prices to decline. This decline in bond prices can further exacerbate deflationary pressures in the economy.
Lower interest rates:
- Lower interest rates are a characteristic of a liquidity trap. In a liquidity trap, the central bank reduces interest rates to stimulate borrowing and investment in the economy. However, when interest rates are already near zero, further reductions have limited impact on stimulating economic activity. This is because individuals and businesses may be hesitant to borrow and invest even at very low interest rates due to uncertainties about the future and lack of confidence in the economy.
High savings rates:
- High savings rates are also a characteristic of a liquidity trap. In a liquidity trap, individuals and businesses tend to save more and spend less. This is because they may be uncertain about the future and prefer to hold onto their money rather than spending or investing it. High savings rates can further contribute to a decline in aggregate demand and economic stagnation.
In summary, a liquidity trap is characterized by a decline in bond prices, lower interest rates, and high savings rates. These factors contribute to a lack of effective monetary policy tools to stimulate economic growth and combat deflationary pressures.
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Which of the following characterise a situation of a liquidity trap in an economy? Decline in bond prices Lower interest rates 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 characterise a situation of a liquidity trap in an economy? Decline in bond prices Lower interest rates 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 characterise a situation of a liquidity trap in an economy? Decline in bond prices Lower interest rates 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 characterise a situation of a liquidity trap in an economy? Decline in bond prices Lower interest rates 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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