A liquidity trap is a situation in which people and businesses prefer holding cash even when interest rates are extremely low.
In this condition, conventional monetary policy becomes less effective. A central bank may lower its policy rate, but borrowers may remain cautious and savers may continue to hold liquid money rather than buy bonds or make new investments. If many people expect weak growth or falling prices, they may postpone spending further.
The concept is associated especially with John Maynard Keynes, who discussed it in his analysis of interest and money. Economists debate how frequently a pure liquidity trap occurs and how it should be identified in real economies.
A liquidity trap is not simply any period of low interest rates. It refers to a stronger condition in which additional money balances do little to reduce rates or stimulate demand. Governments may respond with fiscal policy, while central banks may use asset purchases, forward guidance, or other unconventional measures.