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Recession of 2008 and Liquidity Trap


As expansionary monetary policy was aggressively used in the 2007-09 recession, many economists were fearful that we might be entering into the "liquidity trap." What did these economists mean?


They were fearful that the rapid expansion of real GDP and reduction of unemployment would generate significant inflation.


They were fearful that the expansionary monetary policy would lead to "too much investment," producing too many goods, and another round of aggregate demand being too low compared to aggregate supply.


They were fearful an excess demand for investment funds would in turn raise interest rates in the loanable funds market.


There were fearful that nominal interest rates were already so low (near zero) that monetary policy could not lower the nominal commercial interest rate any further. Thus, the policy would be ineffective.