Definition of liquidity trap
A liquidity trap is a situation in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.
Examples of liquidity trap in the following topics:
- Economists generally believe that deflation is a problem in a modern economy because they believe it may lead to a deflationary spiral .In the IS/LM model (Investment and Saving equilibrium/ Liquidity Preference and Money Supply equilibrium model), deflation is caused by a shift in the supply-and-demand curve for goods and services, particularly with a fall in the aggregate level of demand.
- This can produce a liquidity trap.