Japan's Liquidity Trap

The liquidity trap is an economic situation, first described in Keynesian Economics (Keynes, 1960), where a further increase in money supplies does not increase the rate of interest and income. Thus it fails to stimulate economic growth. The interest rate has already fallen so much that people prefer holding on to cash rather than investing in bonds (or other instruments) because the interest earned is very low. It is an extreme event that happens when people expect adverse events like wars, deflation, etc. Extremely low-interest rates and an increase in the money supply that does not transfer into an increase in the price level are two important features of a liquidity trap. Such a situation renders monetary policy ineffective.