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Chapter 16: Q9. (page 347)

True or False: A liquidity trap occurs when expansionary monetary policy fails to work because an increase in bank reserves by the Fed does not lead to an increase in bank lending.

Short Answer

Expert verified

The given statement is true.

Step by step solution

01

Step 1. Reason for the statement being true

A liquidity trap is a situation where people prefer to save even at a very low-interest rate.

The monetary policy becomes ineffective when it comes to taking expansionary measures, and the Fed keeps reducing the interest rate, but the money supply is not increased as people prefer to hold cash or invest in high-yielding bonds.Therefore, the economy falls into a liquidity trap.

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Most popular questions from this chapter

Explain the links between changes in the nation's money supply, the interest rate, investment spending, aggregate demand, real GDP, and the price level.

What is the basic determinant of (a) the transactions demand and (b) the asset demand for money? Explain how to combine these two demands graphically to determine total money demand. How is the equilibrium interest rate in the money market determined? Use a graph to show how an increase in the total demand for money affects the equilibrium interest rate (no change in the money supply). Use your general knowledge of equilibrium prices to explain why the previous interest rate is no longer sustainable.

Refer to the table for Moola below to answer the following questions. What is the equilibrium interest rate in Moola? What is the level of investment at the equilibrium interest rate? Is there either a recessionary output gap (negative GDP gap) or an inflationary output gap (positive GDP gap) at the equilibrium interest rate, and, if either, what is the amount? Given money demand, by how much would the Moola central bank need to change the money supply to close the output gap? What is the expenditure multiplier in Moola?

Money Supply (\()

Money Demand (\))

Interest Rate (%)

Investment at Interest Rate Shown (\()

Potential Real GDP (\))

Actual Real GDP at Interest

(Rate Shown) ($)

500

500

500

500

500

800

700

600

500

400

2

3

4

5

6

50

40

30

20

10

350

350

350

350

350

390

370

350

330

310

Assume that the following data characterize the hypothetical economy of Trance: money supply = \(200 billion; quantity of money demanded for transactions = \)150 billion; quantity of money demanded as an asset = \(10 billion at 12 percent interest, increasing by \)10 billion for each 2-percentage-point fall in the interest rate.

a. What is the equilibrium interest rate in Trance?

b. At the equilibrium interest rate, what are the quantity of money supplied, the quantity of money demanded, the amount of money demanded for transactions, and the amount of money demanded as an asset in Trance?

A bank currently has \(100,000 in checkable deposits and \)15,000 in actual reserves. If the reserve ratio is 20 percent, the bank has ______ in money-creating potential. If the reserve ratio is 14 percent, the bank has _______ in money-creating potential

a. \(20,000; \)14,000

b. \(3,000; \)2,100

c. −\(5,000; \)1,000

d. \(5,000; \)1,000
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