Liquidity Trap – Indian Economy – Free PDF Download

• A liquidity trap is when monetary policy becomes ineffective due to very low interest rates combined with consumers who prefer to save rather than invest in higher-yielding bonds or other investments.
• While a liquidity trap is a function of economic conditions, it is also psychological since consumers are making a choice to hoard cash instead of choosing higher-paying investments because of a negative economic view.
• This isn’t limited to bonds. It also affects other areas of the economy, as consumers are spending less on products which means businesses are less likely to hire.
• Some ways to get out of a liquidity trap include raising interest rates, hoping the situation will regulate itself as prices fall to attractive levels, or increased government spending.

What Causes a Liquidity Trap?

Rates of Interest Getting Low

• the consistently low rate of interest levels directed by the central bank of a country for a long period of time. Though the main goal of such government policies is to secure robust economic activity, a liquidity trap can soon rise if not operated firmly.

Downturn Trends 

• It emerges when an economy is recuperating from a fall. As governments try to raise economic expansion through expansionary policies to enlarge spending and investment, a diametric effect through an increase in savings level is observed in the market if interest rates are kept too low (close to zero) for a prolonged period.

Unemployment

• An effect of the downturn is rushing levels of unemployment in a country, which intimate decreased incomes in the hands of customers. With a lower fund base, people tend to save any excess funds for meeting any future expenses, instead of devoting them. Thus, a fall in interest rates leads to yield no outcome concerning the betterment of an economy.

Decrement

• Depressed customer demand levels lead to turndown in the price level of an economy. Such trends have a bad effect on the economic growth rate of a country, as it degrades producers from producing greater quantities in turn to lower profits. This develops a harsh impact on the GDP of a country.
• One of the most significant strategies of dominating the liquidity trap in economics is through expansionary fiscal policy.

Increase in Interest Rates 

• If the economy would decrease prices to such a low point that people just cannot resist themselves from shopping. This can happen with customer products or assets like stocks.
• Investors will start purchasing goods again because they are aware they can hold onto the asset for a long run to survive the slump.

The Policy of Expansionary Fiscal 

• The government can abandon the liquidity trap through expansionary fiscal policy. That’s either a tax gash or a rise in government spending, or both.
• That generates motivation that the nation’s leaders will assist economic growth. It also directly develops jobs, decreasing unemployment and the need for reserving cash.

Financial Revolution

• financial innovation generates fresh market liquidity makes financial assets, like stocks, bonds, or derivatives, more glamorous than hoar.

Indian Economy | Free PDF

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