What is a liquidity trap?

Liquidity trap is an economic concept first introduced by Keynes, referring to a situation where, when interest rates fall to very low levels, traditional monetary policies (such as lowering interest rates) lose their ability to stimulate the economy. In this case, people expect interest rates to rise, so they prefer to hold cash rather than invest or consume. Even if the central bank increases the money supply, it cannot further lower interest rates or boost investment and consumption in the economy.

Characteristics of a liquidity trap include:

Stagnant economic growth with severe demand shortfalls.
Interest rates have reached their lowest level, with nominal rates significantly reduced, even to zero or negative levels.
The elasticity of money demand to interest rates tends to infinity, meaning money demand becomes insensitive to changes in interest rates.