A liquidity trap occurs when interest rates are very low, close to zero, and monetary policy becomes ineffective in stimulating economic growth because people hoard cash instead of investing or spending it.
Related terms
Zero Lower Bound (ZLB): The ZLB refers to the lowest possible level that central banks can reduce nominal interest rates before they reach zero percent. It represents an obstacle for monetary policy since it limits the central bank's ability to further stimulate the economy through interest rate adjustments.
Deflation: Deflation is a sustained decrease in the general price level of goods and services. It can contribute to a liquidity trap as individuals delay spending, expecting prices to continue falling.
Quantitative Easing (QE): QE is an unconventional monetary policy tool used by central banks to stimulate the economy when traditional methods become ineffective. It involves purchasing long-term securities, such as government bonds or mortgage-backed securities, with newly created money in order to increase liquidity in financial markets.