Investments glossary

Liquidity Trap

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Quotes of the day:

It is especially important to encourage unorthodox thinking when the situation is critical At such moments every new word and fresh thought is more precious than gold. Indeed, people must not be deprived of the right to think their own thoughts.

— Boris Nikolayevich Yeltsin

A liquidity trap is a contradictory economic situation in which interest rates are very low and savings rates are high, rendering monetary policy ineffective. 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). 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. 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.

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