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The Liquidity 'Trap'ped? Trivia Quiz

In an economic environment bubbling with uncertainty following The Great Recession, the mighty (puny?) economists have settled on the liquidity trap as one of the major mischief makers. Do you know much about this monetary sensation?

A multiple-choice quiz by harsh_skm. Estimated time: 6 mins.

Author
harsh_skm

Time
6 mins

Type
Multiple Choice

Quiz #
348,256

Updated
Dec 03 21

# Qns
10

Difficulty
Tough

Avg Score
6 / 10

Plays
295

One at a Time - Single Page - Timed Game

Question 1 of 10

1. What happens to public preferences with regards to bonds and money during a liquidity trap at the zero lower bound? Hint

They seem almost like interchangeable assets because of no returns

The demand for money vis-a-vis bonds increases due to weak economic performance

The demand for bonds vis-a-vis money increases due to capital flight for safe assets

The demand for both fall as people use their savings to pay off previous debt

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Question 2 of 10

2. When the liquidity trap is in place, what kind of stimulative policy is ineffective? Hint

Fiscal Policy

Conventional Monetary Policy

Balanced Budget Policy

Inflation-augmentation Policy

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Question 3 of 10

3. How does conventional monetary policy, which in the US means injecting cash into the economy by the Federal Reserve by buying bonds from the market, usually stimulate the economy? Hint

By lowering the debts of the private sector and allowing them to spend more

By increasing the interest rates, thus giving people an incentive to save more through a higher rate of return on their savings

By increasing the price of government bonds which improves the currency and the nation's international competitiveness

By lowering interest rates, thus giving an incentive for businesses to invest and consumers to borrow and spend

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Question 4 of 10

4. Why is a Fiscal Stimulus effective in a liquidity trap? Hint

The infrastructure put in place replaces missing private sector investment

Since the interest rates won't rise, it fills the aggregate demand gap as there is no crowding out of the private sector

The resulting rise in inflation lowers the debt burden of the private sector

It increases the confidence in the economy

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Question 5 of 10

5. Whose masterful theories, later polished by the technical master John Hicks, led to the first real insights into the liquidity trap? Hint

Friedrich Hayek

Paul Samuelson

Milton Freidman

John Maynard Keynes

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Question 6 of 10

6. Which nation's economy suffered the wrath of the liquidity trap during the 1990s, causing, as some say, the 'lost decade' of growth? Hint

Japan

Thailand

Russia

Argentina

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Question 7 of 10

7. What usually brings about the onset of a liquidity trap? Hint

A Financial Crisis

An Aggregate Demand Crisis

A Balance Sheet Crisis

War

8. Which Taiwanese economist is an expert on the Balance Sheet Recession, and the author of a 2011 research paper titled "The world in balance sheet recession: Causes, cure, and politics" which went viral on the web in the economic/financial circles? Hint

Charles Horioka

Shigeto Tsuru

Richard Koo

Yasuma Takada

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Question 9 of 10

9. What monetary phenomenon is accompanied with a liquidity trap? Hint

Inflation

Disinflation

Deflation

Stagflation

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Question 10 of 10

10. In regular times, increased aggregate __________ is usually good for GDP growth in the medium run, and even if it is too high, it does not do too much damage. In a liquidity trap brought on by a balance sheet recession, however, increased ___________ can do a lot of damage to both the short run and the medium run growth rate of GDP. Fill in the blank. Hint

consumption

deflation

savings

investment

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Quiz Answer Key and Fun Facts

1. What happens to public preferences with regards to bonds and money during a liquidity trap at the zero lower bound?

Answer: They seem almost like interchangeable assets because of no returns

The zero lower bound, government bonds with an approx. 0% nominal yield rate, has been seen in the US economy after the onset of the 2008 recession. Since the public may prefer money over assets which offer returns (negligible), this situation is called the Liquidity Trap. Why the 'Trap', you ask? Well, play on, my dears.

2. When the liquidity trap is in place, what kind of stimulative policy is ineffective?

Answer: Conventional Monetary Policy

Or technically speaking, the LM (Liquidity preference - Money supply) curve is horizontal on the IS-LM plane.

3. How does conventional monetary policy, which in the US means injecting cash into the economy by the Federal Reserve by buying bonds from the market, usually stimulate the economy?

Answer: By lowering interest rates, thus giving an incentive for businesses to invest and consumers to borrow and spend

Of course, in a liquidity 'trap'ped economy, the interest rates cannot be further lowered. So, conventional monetary policy is ineffective.

4. Why is a Fiscal Stimulus effective in a liquidity trap?

Answer: Since the interest rates won't rise, it fills the aggregate demand gap as there is no crowding out of the private sector

The Government should be spending a lot of money on useful things like infrastructure during a liquidity trap, especially if the bond rates are near 0%. Most economists who believe this theory say the desired fiscal stimulus for the 2008-11 crisis should have been around 1.5-$2 trillion over the course of 2 years.

5. Whose masterful theories, later polished by the technical master John Hicks, led to the first real insights into the liquidity trap?

Answer: John Maynard Keynes

The great Keynes expounded the greatest economic insights of the 20th century in 'The General Theory of Employment, Interest and Money'. Many of these insights came through his observations during the Great Depression, which was the first time that the liquidity trap presented itself to the world.

6. Which nation's economy suffered the wrath of the liquidity trap during the 1990s, causing, as some say, the 'lost decade' of growth?

Answer: Japan

Japan has been suffering for almost two decades starting in the 90s, with a low GDP growth rate of 1.4% and a stagnated economy.

7. What usually brings about the onset of a liquidity trap?

Answer: A Balance Sheet Crisis

In a balance sheet recession, private sector is deleveraging and as a result there are no takers for monetary stimulus. It just keeps circulating in the financial sector.

Answer: Richard Koo

Richard Koo held the position of Chief Economist of the Nomura Research Institute in Japan during the Great Recession of 2008-11. He clearly underlines the differences between a normal recession and a balance sheet recession.

9. What monetary phenomenon is accompanied with a liquidity trap?

Answer: Disinflation

The liquidity trap should really be accompanied by deflation, but in the real world, the phenomenon of sticky wages and sticky prices lead to a very low rate of inflation through the process of disinflation. It doesn't mean that the disinflation will last for the entire length of the liquidity trap. Eventually inflation may take hold.

Answer: savings

This is because, as it is, there is a shortfall of demand (aggregate demand) as people try to deleverage. Increased savings at a time when businesses are not investing those savings for new production (because of low demand) leads to a lower GDP growth rate.

It would be better to put that money into consumption. Since that is not possible for individuals to do, so the fiscal stimulus becomes even more necessary to plug the demand gap.

Source: Author harsh_skm

This quiz was reviewed by FunTrivia editor stedman before going online.
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