Answer to Question #171619 in Macroeconomics for Zaheer

Question

Using the IS-LM framework, under what conditions and for what reasons is monetary policy impotent ?

Answer 1

In times of crisis, such as during the Depression, monetary policy become impotent due to a phenomenon known as the liquidity trap. The existence of a liquidity trap, which is where individuals hoard - instead of spend - cash when interest rates are low, means that governments must use expansionary fiscal policy (i.e. increase their spending) during downturns.