When the economy is in a liquidity trap with a zero interest rate, what happens to output when prices decrease?
A) Output decreases.
B) Output does not change.
C) Output initially decreases then increases.
D) Output increases.
E) Output initially increases then decreases.

Question

Quizplus · Accepted Answer

In a liquidity trap with a zero interest rate, there is no scope for monetary policy to stimulate aggregate demand. As a result, a decrease in prices does not have an effect on output as there is no incentive for consumers to increase consumption and businesses to increase production. Therefore, output does not change.

When the Economy Is in a Liquidity Trap with a Zero