Liquidity Trap

by dmc11hawks on Nov 11, 2010

Recorded on November 11, 2010 using a Flip Video camcorder.

Definition

Situation where bank cash-holdings are rising and banks cannot find sufficient number of qualified borrowers even at extraordinary low rates of interest. It usually arises where people are not buying and firms are not borrowing (for inventory or plant and equipment) because economic prospects look dim, investors are not investing because expected returns from investments are low, and/or a recession is beginning. People and businesses hold on to their cash and thus get trapped in a self-fulfilling prophecy.

What Does Liquidity Trap Mean?
A 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.

Read more: http://www.investopedia.com/terms/l/liquiditytrap.asp#ixzz1dSUGAvLs

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