What can happen during a liquidity trap?

During a liquidity trap, the economy experiences a situation where interest rates are very low, and savings rates are stable or increasing. This phenomenon occurs when monetary policy becomes ineffective because people hoard cash instead of spending or investing. Even though the central bank may lower interest rates to stimulate borrowing and spending, consumers and businesses may still hold on to their cash due to pessimism about future economic conditions or the inability to find beneficial investment opportunities.

As a result, economic growth can stagnate or decline despite the availability of cheap money. The expectation of low return on investment or concerns about economic stability can hinder spending. Thus, individuals may choose to save rather than invest, leading to weak economic growth, which is characteristic of a liquidity trap. In this context, the correct answer highlights the struggle an economy faces to gain momentum even when monetary policy is accommodative.