A liquidity trap is a situation in which nominal interest rates are near zero and additional money creation is held as cash rather than spent. Conventional monetary policy becomes less effective because the policy rate cannot fall much further.

In a debt-driven liquidity trap, deleveraging pushes the economy below full employment, and the zero lower bound prevents the real interest rate from falling enough to restore equilibrium. Fiscal policy and expectations management can become more important.[1]

The concept is closely associated with deflation risk and balance-sheet recessions.[2]

Sources

  1. Eggertsson, Gauti B.; Krugman, Paul. Debt, Deleveraging, and the Liquidity Trap. Quarterly Journal of Economics. 2012. View source Accessed Nov 11, 2026.
  2. International Monetary Fund. Deflation: Determinants, Risks, and Policy Options. IMF. 2003. View source Accessed Nov 11, 2026.