Question

Monetary policy focuses on adjusting the supply of money in the economy to manage inflation and unemployment. However, it is not without it's limitations. One of the limits is that by reducing interest rates, the FED seeks to stimulate borrowing and thus purchasing. However, is there a lower limit where if rate goes down any lower people don't borrow any additional money to buy things? Some countries have reached interest rates of zero (Japan and Finland) and even taken them into negative territory - yes, that means you actually pay back less than you borrow! Currently in the U.S. interest rates are at historic lows (and even were negative for a day or two late last year). Have we reached that point where lower rates have no effect on borrowing and spending? Economists call this a "Liquidity Trap." Is the United States entering a liquidity trap?

Answer 1

The liqidity trap is a phenomena where the the interest rates are very low thus making the monetary policies a faliure. During this time a financial institution wants you to borrow money from bank and expend it in buisinesses and bonds. But what actually happens is that as the borrowing of money's rate declines as well as the savings rate also declines simultaneously and the people who had saved in a bank or are willing to save in a bank will either withdraw the money or be refrained from saving it in a bank. Thus the bank will gradually loose the savings and there will be no funds that will be loaned to the people. This financial trap is called the luqudity trap.

In United states the interrest that banks charge was 2.25% to 2.5% in July 2019 and the federal reserve are reducing it far below to make the economy more stronger and the rates go to 0.25% in March 2020. Their plan is to make people spend more so that the economic stabilty is not hindered. But as the savings are taken out of the banks due to low interest rates the plan is failing. United states is not necessarily is enterning a liqudity trap because different Fiscal reforms have been made since March '20 and improvement in economy is in sight.