Liquidity Trap

DEFINITION of 'Liquidity Trap'

A situation in which prevailing interest rates are low and savings rates are high, making monetary policy ineffective. In a liquidity trap, consumers choose to avoid bonds and keep their funds in savings because of the prevailing belief that interest rates will soon rise. 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.

BREAKING DOWN 'Liquidity Trap'

Should the regulatory committee try to stimulate the economy by increasing the money supply, there would be no effect on interest rates as people do not need to be encouraged to hold additional cash.

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