CFA Practice Question

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CFA Practice Question

In a liquidity trap, ______

I. the short-term nominal interest rate is zero.
II. monetary policy becomes completely ineffective.
Correct Answer: I and II

I. In this case, increasing money in circulation has no effect on either output or prices.

II. Consumers choose to avoid bonds and keep their funds in savings.

User Contributed Comments 3

User Comment
jonan203 also known as keynesian end point...
ConcerNinE I don't understand why the nominal interest rate is 0 in this case. Could someone help me ?
Corey678 @ConcerNinE . I think its saying: "What should the Fed do in a liquidity trap situation"? Economics states low rates= higher supply of money so the Fed is trying to raise money supply/increase money velocity/positively spike demand by cutting rates to 0 (i.e. low rate) and increase liquidity. But the trap is reducing the effectiveness of the monetary policy implemented by the fed.
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