1.4.1 Paul Krugman, a former recipient of the Bank of Sweden Nobel Memorial Prize in Economics, famously depicted the economic situation in Japan in the 1990s as a “liquidity trap”, whereby interest rates were already so low that Japanese consumers would hold additional liquidity without changing their interest rates expectations. What happens to the money demand curve in such case? Why does monetary policy fail to lower interest rates? Explain with the help of a graph.

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0 Interest rate, r Money, M M pW