Question 98 from UPSC CSE 2020 - ECONOMICS

Question

If you withdraw Rs. 1,00,000 in cash from your Demand Deposit Account at your bank, the immediate effect on aggregate money supply in the economy will be

Accepted Answer

Correct Option: D. to leave it unchanged

Strategy: Focus on the components of money supply. Withdrawing cash converts demand deposits into physical currency, but both forms count as part of the money supply. Therefore, the sum total remains unaffected because currency in circulation replaces deposits, resulting in no net immediate change in the aggregate money supply.

Key Info: Money supply in India is commonly measured by aggregates classified by the Reserve Bank of India (RBI), such as M1, M2, M3, and M4.

- **M1 (Narrow Money)**: Consists of Currency with the public (C), Demand deposits with the banking system (DD), and Other deposits with the RBI (OD).
  Formula: M1 = C + DD + OD.
- **M3 (Broad Money)**: M3 = M1 + Time Deposits (TD) with the banking system. M3 represents the total purchasing power in the economy and is often referred to as 'money supply.'

A withdrawal of cash from a demand deposit reduces the Demand Deposits (DD) component while increasing the Currency with the public (C) by the same amount. As both components are included in M1 and M3, this transaction has no net immediate effect on the total money supply.

Key Definitions:
- **Currency with the public**: Includes all notes and coins held by entities other than the RBI, government, or banks.
- **Demand deposits**: Funds that can be withdrawn from banks without notice, such as savings and current accounts.
- **Time deposits**: Account balances, like fixed or recurring deposits, held for a specified period.

Aggregate money supply is a crucial metric for analyzing monetary policy and liquidity within the economy. Changes in public behavior that merely swap between different forms of money (e.g., cash and bank deposits) do not, by themselves, alter the overall quantum of money supply.

Answer

Option A: to reduce it by Rs. 1,00,000

Answer

Option B: to increase it by Rs. 1,00,000

Answer

Option C: to increase it by more than Rs. 1,00,000