Concept of liquidity trap

Refers to the minimum rate of interest payable to persons to persuade them to part with money in terms of savings or investment i.e. interest being the payment for the loss of liquidity. It inversely relates the speculative demand for money to the interest rate (as a return).
This concept is derived from the Keynesian Theory (monetary theory of interest) of speculative demand for money. It states that the rate of interest is determined the supply of money (savings) and the desire to hold one’s wealth in money/cash (demand for money).
It looks at money as a store of value (in itself), that is, money is held as an asset in preference to income – yielding assets such as a government bond.
Lord John Maynard Keynes (1936) explains the speculative demand for money in terms of the buying and selling of government securities or treasury bills (TBS) on which the government pays a fixed rate of interest.
Its assumed that the speculative demand for money is interest elastic such that the demand curve slopes downwards from left to right.
At the liquidity trap point, the demand cure is perfectly elastic implying that any interest rate below the persuasive minimum interest rate represents an absolute preference for liquidity situation i.e. no spectacular will be willing to (part with money) invest in government securities.



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