“The liquidity trap - a situation in which conventional monetary policy loses all traction” (Paul Krugman, March 2008). In normal circumstances, monetary policy can be a powerful instrument in managing aggregate demand, output and inflationary pressures and smoothing the impact of external economic shocks. But on occasions, monetary policy can become ineffective – the liquidity trap is associated with this.

Briefly, a liquidity trap occurs when the nominal (or money) interest rate is close or equal to zero, and the central banks find that they have run out of room to stimulate demand during a slowdown or a recession. The rest of the two page revision note can be downloaded from the link below.

Revision note on the liquidity trap
Revision_Liquidity_Trap.pdf