What is a liquidity trap in economics?

A liquidity trap occurs when interest rates are already low, and monetary policy becomes ineffective in stimulating economic activity. In such a scenario, consumers and businesses may hoard cash rather than spend or invest, despite low interest rates. This lack of demand for loans and spending can cause prolonged economic stagnation. A liquidity trap is often associated with periods of deflation or low inflation, where monetary policy tools like lowering interest rates do not encourage additional economic growth. In these situations, fiscal policy, such as increased government spending, may be necessary to jump-start the economy.