Liquidity Trap

A situation in which very low interest rates make monetary expansion ineffective at stimulating spending. In this condition, people may prefer holding money to buying bonds or spending.

Zero Lower Bound: A limit on how far central banks can lower nominal interest rates, historically near zero. When rates approach this bound, conventional rate cuts leave little room to stimulate demand.
John Maynard Keynes: British economist whose work shaped modern macroeconomics and the theory of aggregate demand. Keynes gave the liquidity-trap idea its influential account in the 1930s.
Forward Guidance: Central-bank communication about the likely future path of monetary policy. Promises to keep rates low can affect borrowing costs even when current rates cannot fall much.
Monetary Policy: Central-bank actions that influence money, credit, and interest rates to affect economic conditions. A liquidity trap is a constraint on one major channel of monetary policy, not a separate policy regime.
Aggregate Demand: The total planned spending on final goods and services at different price levels. A trap matters because monetary expansion may fail to shift aggregate demand enough to restore output.
Liquidity Preference: The desire to hold wealth as money rather than less liquid assets. In a liquidity trap, exceptionally strong money demand absorbs monetary expansion.
The General Theory of Employment, Interest and Money: John Maynard Keynes’s 1936 book explaining output and employment through aggregate demand. Keynes discussed circumstances in which monetary policy could not reduce interest rates further.
Negative Interest Rate Policy: A policy that sets selected central-bank interest rates below zero. It attempts to push beyond the usual rate floor, though cash and financial-system constraints remain.
Deflation: A sustained decline in the general price level. Deflation can raise real borrowing costs at zero nominal rates and deepen a liquidity trap.
Output Gap: The difference between actual economic output and its sustainable potential level. Weak stimulus can leave a large negative output gap in place for longer.

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