In the 1990s and early 2000s, Japan's central bank reduced real interest rates to zero percent, but investment spending did not respond enough to bring the economy out of recession. Japan's experience is an illustration of:

A. the crowding-out effect.

B. the liquidity trap.

C. the Taylor rule.

D. "pulling

Answer: B - Liquidity Trap

Explanation:

Liquidity trap is an economic situation in which monetary policy becomesineffective due to low interest rates and high savings rates.

Bonds have an inverse relationship to interest rates, therefore consumers would want to keep Thier funds in cash believing that interest rate may soon rise in near future

At the same time, central bank efforts to increase economic activity are terminated as they are unable to lower interest rates to provide incentives to investors and consumers and without demand, businesses would not grow.

Here, in the case of Japan, the central bank reduced real interest rates to zero percent, but investment spending did not respond enough to bring the economy out of recession making Japan experience Liquidity Trap

The correct answer is letter "B": the liquidity trap.

Explanation:

A liquidity trap takes place when the central bank sets the interest rate low to boost spending but people, instead, prefer to save with the expectations the interest rate will increase at any moment. British economist John Maynard Keynes (1883-1946) was the first referring to this concept while talking about bonds. According to Keynes, when the government would decrease the interest rates, investors would keep their bonds hoping in front of an increase in interest rates they would increase their returns.