What is a liquidity trap?

Liquidity traps are financial situations where a factor that usually stimulates the economy does not reach the required reaction. One example of liquidity traps is when interest rate drop motivates consumers to buy more goods and services on credit. Trap may also develop when most financial assets are tied in poor quality accounts, making it difficult or impossible to convert these non -interior sources into liquid assets that can be used for new purchases or acquisitions.

John Maynard Keynes is often identified as the inventor of the concept of liquidity trap. Keynes developed this theory for the first time in the middle of a major economic crisis in the United States in the mid -30s. Keynes essentially pointed out the events of recent years and noted how events leading to the stock market in 1929 and the prevailing attitudes of creditors and debtors during depression created a situation where the usual economic stimulators did not create the required effect.

Although there is no economic depression, it is possible thata liquidity trap will appear. If consumers suspect that interest rates are likely to fall below the current level, they may decide to avoid new debt for a certain period of time. This is true, although interest rates have recently dropped. As long as the rates are expected to drop even further, consumers will delay lending or large purchases.

Another approach to liquidity trap focuses on creditors rather than consumers. If creditors perceive that the usual indicators in the monetary economy point to an increase in loans and credit account failure, they can be very selective when writing a new debt. This means that consumers who are normally able to obtain a relative ease of ease can suddenly get a loan or a higher interest rate.

Interest rates on savings accounts are often relatively high during liquidity trap, while interest rates on loans and credit cards areLow. Along with the suspicion that interest rates on credit accounts may drop, consumers may also want to avert liquid assets to savings accounts and take high interest on these accounts while they can. This combination of circumstances further motivates consumers to save rather than spend.