Answer to Question #64060 in Economics for Genie

Question

Keynes suggested that monetary policy may completely ineffective if there is a liquidity trap. Why would this be true.

Answer 1

Liquidity trap is the 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.
This makes monetary policy ineffective indeed.