An increase in money supply wil result in a liquidity trap if: A-the preference

Question

An increase in money supply wil result in a liquidity trap if: A-the preference for liquidity is reduced B-there's an increase in the demand for bonds in the same proportion C-there’s a increase in the preference for liquidity in the same proportion D- none of the above
An increase in money supply wil result in a liquidity trap if: A-the preference for liquidity is reduced B-there's an increase in the demand for bonds in the same proportion C-there’s a increase in the preference for liquidity in the same proportion D- none of the above
A-the preference for liquidity is reduced B-there's an increase in the demand for bonds in the same proportion C-there’s a increase in the preference for liquidity in the same proportion D- none of the above

Explanation / Answer

An increase in money supply will result in a liquidity trap if there's a increase in the prefetence for liquidity in the same proportion.

it is so because during liquidity trap the people wants to hold the money as interest rate become ineffective to change the preference of the people.

The people of the economy hold all the money as cash with the fear of losing their money due to adverse effect on the economy like war, deflation etc. They are no more willing to keep their money anywhere in any form except cash so any increase in money supply will increase the preference for liquidity in the same proportion.

Option a) is incorrect because preference for liquidity will always increase in liquidity trap.

Option b ) is also incorrect because people do not want to buy bonds or keep bonds as interest rate become ineffective for them and they want to keep the cash form only.

Option C) is correct as the reason defined above.

Option D) is incorrect because option C) is correct.

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