What characterizes a liquidity trap?

A liquidity trap is characterized by a situation in which interest rates are very low and savings rates are high, leading to a preference for holding onto cash rather than investing it or spending it. In this scenario, monetary policy becomes ineffective because even when the central bank lowers interest rates to stimulate the economy, individuals and businesses may choose to save rather than spend or invest these funds. This occurs because they anticipate that economic conditions are unfavorable, creating a situation where additional liquidity does not stimulate economic activity.

In a liquidity trap, the expectations of future economic outcomes can lead to increased precautionary savings. Folks prefer liquidity, as they perceive the risk of future economic downturns or uncertainty about the inflation rate, which encourages them to hoard cash rather than engage in transactions that would promote further economic activity.

This context clarifies why the characteristic of low interest rates and high savings rates accurately describes a liquidity trap, making it the correct answer to the question.