A liquidity trap occurs when increases in the money

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A liquidity trap occurs when increases in the money supply by the central bank fail to lower interest rates because banks don’t loan out money and/or real interest rates have reached zero.
Combining the transactions and speculative demand for money gives us the money demand curve . The demand for money shifts right (increases) given a change in the transactions demand for money due to:: An increase in the aggregate price level An increase in real GDP Less access to ATM machines and/or credit cards Change in regulations allowing banks to pay interest on checking accounts (1980) MD slopes down because higher interest rates increase the opportunity cost of holding money.
Movement to Equilibrium At 4%, people prefer to hold interest bearing assets and there is a surplus of cash in the market Savers buy bonds driving bond prices up and interest rates down. The market moves to equilibrium at 3%. (Note: Other short-term interest rates are tied to the federal funds rate and will change as well in the same direction.) Federal Funds Rate 3% 2% Quantity of money MS 1 MD 4%
Why are short-term rates different from long- term rates?
Short-term rates were above long-term rates before recession. This is called an “inverted yield curve” and is highly unusual. Reason?
Module 38: Monetary Policy The Fed gathers the following information: CPI is down by 0.4% Real GDP is down by 0.3% The unemployment rate is 8% Sketch an AS/AD graph illustrating what is happening in this economy. What is the problem in this economy and what should the Fed do?
The problem is a recessionary gap caused by a decrease in aggregate demand. We know that it is a recessionary gap because unemployment is above the natural rate; we know that it was caused by a decrease in AD because both the price level and GDP fell. The solution is expansionary monetary policy.
How expansionary money policy impacts the real economy: The Keynesian causation chain
As a result of the decrease in interest rates, interest sensitive spending by consumers and businesses for investment will increase and shift the AD curve to the right. Real GDP increases. The price level will increase if the economy is close to full employment.

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