Question

Assume that the RBA decided to increase its price target, how the economy would change in the liquidity trap

Answer 1

When the reserve bank decided to increase the money supply in a normal situation. The increase in the interest rates will stop and people will force release their holdings of additional cash. But in the liquidity trap situation consumers still, hold the savings. The continued holding of the savings will result in a slow down of the economic growth in the country. Injecting money in the economy in a liquidity trap situation will not improve the economy. To improve the economy the government will need to break this liquidity trap.

To solve the liquidity trap the government can increase the interest rates in the bonds this is a possible solution. The most effective solution to breaking this trap is to create a big drop in the price of goods that will make the consumers spend more to use the situation to get more products.