Answer to Question #52007 in Macroeconomics for Emilia Shindinge

Question

Monetary policy is said to be more effective in the liquidity trap. Do you agree with this statement? Kindly motivate your position by making use of a graph.

Answer 1

The neoclassical economists asserted that, even in a liquidity trap, expansive monetary policy could still stimulate the economy via the direct effects of increased money stocks on aggregate demand. This was essentially the hope of the Bank of Japan in 2001, when it embarked upon quantitative easing. Similarly it was the hope of the central banks of the United States and Europe in 2008–2009, with their foray into quantitative easing. These policy initiatives tried to stimulate the economy through methods other than the reduction of short-term interest rates.
So, monetary policy is said to be more effective in the liquidity trap and the statement is true.