Which of the following best illustrates a liquidity trap?
Interest rates are near zero, but people prefer holding cash instead of investing.
Interest rates are near zero, but people prefer holding cash instead of investing. is correct.
A liquidity trap is a situation described by J.M. Keynes in which interest rates are already very low, close to zero, so further increases in money supply fail to lower rates or boost spending. People expect rates to rise (and bond prices to fall) and simply hoard cash, so monetary policy loses its power to stimulate the economy. Japan in the 1990s and many economies after 2008 are common examples.
Raising interest rates to control inflation is contractionary monetary policy; banks refusing to lend because of default risk is a credit crunch; and raising taxes to cut the fiscal deficit is fiscal consolidation. None of these describes the liquidity trap.
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Which one of the following effects of creation of black money in India has been the main cause of worry to the Government of India?
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