How come inflation does NOT increase if the money supply increases during a liquidity trap? My guess is that if people hold more cash, they would spend more. Given that during a liquidity trap the economy is maxed out and cannot increase output, the extra influx of spending would only serve as to increasing prices. Apparently this is not the case. What happens to the influx of cash? Do people simply hold it? EDIT: I found this, but it doesn't really make sense to me. "Conventionally, the expansion of the money supply will generate inflation as more money is chasing after the same amount of goods available. During a liquidity trap, however, increases in money supply are fully absorbed by excess demand for money (liquidity); investors hoard the increased money instead of spending it because the opportunity cost of holding cash—the forgone earnings from interest—is zero when the nominal interest rate is zero. Even worse, if the increased money supply is through LSAPs on long-term debts (as is the case under QE), investors are prompted to further shift their portfolio holdings from interest-bearing assets to cash."