Previous Year Question
If you withdraw ₹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:
to reduce it by ₹1,00,000
to increase it by ₹1,00,000
to increase it by more than ₹1,00,000
to leave it unchanged
Correct Answer: D
Detailed Solution
According to the RBI, the principal components of Narrow Money, or M1, are:
Where:
C represents currency with the public;
DD represents demand deposits of the public with the banking system; and
OD represents other deposits of the public with the RBI.
A demand deposit is a bank deposit that the account holder can withdraw on demand without prior notice. Current accounts and the demand component of savings accounts are important examples.
When an account holder withdraws ₹1,00,000 in cash from a demand deposit account, two equal and simultaneous changes occur:
the person’s demand deposit with the bank decreases by ₹1,00,000; and
currency held by the public increases by ₹1,00,000.
Thus:
The form of money changes from a bank deposit into currency, but the total amount of money immediately available to the public does not change. M1 therefore remains unchanged.
Broad Money, or M3, includes M1 together with time deposits held with banks. This transaction does not alter time deposits, while M1 remains unchanged. Hence, M3 is also unaffected immediately.
The withdrawal may subsequently affect the bank’s cash position and lending capacity. This can later influence deposit creation or the money multiplier. However, the question asks about the immediate effect, under which aggregate money supply remains unchanged.