Economics

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Akhilesh Mishra

Akhilesh Mishra (Querist)
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07 February 2016 Please let me know about the concept of ''Liquidity Trap''
what is the real meaning of this???

Shashank

Shashank (Expert)
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07 February 2016 Liquidity Trap is a situation defined in Keynesian Economic Theory in which:
- Central Bank's injections of Cash into private banking system
- Fails to decrease the interest rates.
- This is mainly on account of hoarding of cash by people
- expecting an adverse event like deflation, insufficient demand or war.
- The important feature of this concept is the interest rates near to zero, which makes monetary policy ineffective.

In this situation even a zero interest rate is insufficiently low to produce full employment. People do not expect high returns on physical or financial investments, so they keep assets in short-term cash bank accounts or hoards rather than making long-term investments. This makes the recession even more severe. Japan is the current example of Liquidity Trap.

Akhilesh Mishra

Akhilesh Mishra (Querist)
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07 February 2016 Thank you shashank, but in your explanation you said about the ''zero interest rates'', kindly clear the image on this.

Shashank

Shashank (Expert)
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07 February 2016 It means Central Bank Nominal Interest Rates equals or close to zero.
In Such a scenario, the short term deposits will not fetch any interest, or say, the rate of interest would be zero.
In some extreme cases, like currently in Japan, there might be negative rates. It means you will actually have to pay interest on the money you keep as a deposit in a bank. Yes, you read it right, you will be paying an interest on your FDs.

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