Question

In the case of ‘liquidity trap’, ..........

• A. expansionary monetary policy is highly effective
• B. expansionary monetary policy raises supply of money leading to hyperinflation
• C. as the central bank increases the money supply, the interest rate will fall significantly
• D. expansionary monetary policy is completely ineffective

Hint:

In a liquidity trap, monetary policy becomes ineffective because interest rates are already at very low levels, and people prefer holding money rather than spending or investing it.

Answer 1

The Correct Option is D

Step 1: Understand the liquidity trap.
A liquidity trap occurs when interest rates are so low that they cannot be reduced further to stimulate investment. In this situation, the demand for money becomes highly elastic, and increasing the money supply does not lead to increased investment or consumption.
Step 2: Analyze the options.
- Option (A) is incorrect because in a liquidity trap, monetary policy becomes ineffective as the economy is stuck with low interest rates and no incentive to borrow more.
- Option (B) is incorrect because hyperinflation is not typically associated with a liquidity trap.
- Option (C) is incorrect because interest rates cannot fall significantly in a liquidity trap, as they are already near zero.
- Option (D) is correct. In a liquidity trap, expansionary monetary policy, such as increasing the money supply, does not effectively stimulate the economy because the demand for money becomes perfectly elastic.
Final Answer: \[ \boxed{\text{expansionary monetary policy is completely ineffective}} \]