UPSC Prelims 2020 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

Explanation:

• The money supply is the total amount of money - cash, coins, and balances in bank accounts and in circulation. The money supply is commonly defined to be a group of safe assets that households and businesses can use to make payments or to hold as short-term investments.
  
  

• • There are four components of money supply: M1, M2, M3 and M4

• M1 = CH + DD + OD 

'CH' is the currency held by the public individual, households and companies (excluding government and the banks). It does not include inter-bank deposits and government deposits in the banks.

'NDD' is net demand deposits by the public in the banks.

'OD' is other deposits. These are the deposits with the RBI, held by certain individuals and institutions.

• M3 = M1 + TD

'TD' means time deposits. M3 represents the total money supply in general.

• When a person withdraws Rs. 1,00,000 in cash from Demand Deposit Account, then the Demand Deposit component will fall by Rs. 1,00,000, and the Currency held by the public will increase by Rs. 1,00,000. Therefore, in the given case the money supply will remain unchanged.
  
  

Therefore, option (4) is the correct answer.

Subject: Economics | Money and Banking