Question

When a liquidity trap situationâ exists, we knowâ that:_____.a. fiscal policy will have no effect on the demand for goods.b. an open market operation will have no effect on the interest rate.
c. expansionary monetary policy will be deflationary.
d. fiscal policy will have no effect on the demand for goods.
e. an open market operation will have no effect on the monetary base.

Answer 1

Answer:

b. an open market operation will have no effect on the interest rate

Explanation:

In any situation of of liquidity trap, money demand curve is always almost flat. As a result of this, a shift in the money supply curve (resulting from an open market operation) does not cause much or any change in the market interest rate. An open market operation can affect the money supply even during liquidity trap. The monetary base in affected, without exception, when an open market operation takes place. An expansionary monetary policy increases price levels and is therefore never deflationary. It is the monetary policy, not the fiscal policy, that is rendered ineffective in the case of liquidity trap.