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Which of the following is a situation of the very low rate of interest in the economy where every economic agent expects the interest rate to rise in future and consequently bond prices to fall, causing capital loss?
1. Revenue deficit 
2. Parametric shift
3. Paradox of thrift
4. Liquidity trap

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Correct Answer - Option 4 : Liquidity trap

The correct answer is a Liquidity trap.

  • The paradox of thrift is an economic theory that argues that personal savings can be detrimental to overall economic growth.
  • It is based on a circular flow of the economy in which current spending drives future spending.

  • A liquidity trap is a situation of the very low rate of interest in the economy where every economic agent expects the interest rate to rise in the future and consequently bond prices to fall, causing capital loss.
    • A liquidity trap is an economic situation where everyone hoards money instead of investing or spending it.
    • It occurs when interest rates are zero or during a recession.
    • People are too afraid to spend so they just hold onto the cash.
    • As a result, central banks' use of expansionary monetary policy doesn't boost the economy.
    • A liquidity trap is a situation when expansionary monetary policy does not increase the interest rate, income and hence does not stimulate economic growth.
  • Hence, option 4 is correct. 

  •  Revenue deficit :
    •  A revenue deficit occurs when realized net income is less than the projected net income.
    • This happens when the actual amount of revenue and/or the actual amount of expenditures do not correspond with budgeted revenue and expenditures.
    •  Revenue deficit = Total revenue expenditure – Total revenue receipts
    •  Fiscal deficit = Total expenditure – Total receipts excluding borrowings
  • The paradox of thrift :
    • The paradox of thrift is a paradox of economics.
    • The paradox states that an increase in autonomous saving leads to a decrease in aggregate demand and thus a decrease in gross output which will, in turn, lower total saving.
    • The paradox of thrift refers to contrasting implications of savings to households and to the economy as a whole.
    • Saving is treated as a virtue by households as they provide a protective umbrella against bad spells but the same is treated as a vice by the economy as it retards the process of income generation.

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