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
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- Ato reduce it by Rs. 1,00,000
- Bto increase it by Rs. 1,00,000
- Cto increase it by more than Rs. 1,00,000
- Dto leave it unchanged
Show answer
Answer: (D) to leave it unchanged
This is a classic economics concept question.
Let's understand it step by step.
Money supply in India is measured as M1 or M3:
- M1 = Currency with public (C) + Demand Deposits (DD) + Other Deposits
- M3 = M1 + Time Deposits (this is the commonly used measure)
Now, when you withdraw Rs. 1,00,000 from your bank account:
- Your Demand Deposit (DD) decreases by Rs. 1,00,000 (money leaves your bank account)
- But your Currency in hand (C) increases by Rs. 1,00,000 (you now have cash)
So one component goes down, and another goes up by the exact same amount.
The total money supply (M1 or M3) stays the same!
It's like pouring water from one glass to another — the total amount of water doesn't change.
Answer: D (Money supply remains unchanged).
Key Takeaway: Withdrawing cash from a bank just converts demand deposits into currency.
Total money supply = unchanged.
This is a very commonly asked concept in UPSC.
Money supply measures like M1 and M3 include both currency in circulation and bank deposits as components of the total money stock.
When cash is withdrawn from a bank account, one component of money supply (demand deposits) decreases while another component (currency with public) increases by exactly the same amount.
Money Supply Components in India
Indian Economy aggregate money supply Demand Deposit cash
Money Supply Components: M1, M3 & How UPSC Tests This
M1 = Currency with public + Demand deposits + Other deposits with RBI
M3 = M1 + Time deposits (most commonly used measure)
Converting demand deposit to cash keeps total money supply unchanged
RBI publishes money supply data monthly
What is Money Supply
Money supply is the total stock of money circulating in an economy at any given time. The Reserve Bank of India (RBI) measures this using different aggregates — M1, M2, M3, and M4 — with each including broader categories of money.
RBI Money Supply Measures
Measure | Components | Nature | Usage |
|---|---|---|---|
M1 | Currency + Demand deposits + Other deposits | Narrow money | Most liquid, immediate spending power |
M2 | M1 + Savings deposits with Post Office | Slightly broader | Includes postal savings |
M3 | M1 + Time deposits | Broad money | Most commonly used by RBI |
M4 | M3 + All deposits with Post Office | Broadest measure | Comprehensive view |
Question Context
The 2020 PYQ tests whether students understand that withdrawing ₹1,00,000 cash from a demand deposit simply converts one form of money to another within the same M1 category. Total money supply stays unchanged.
Trap: Thinking cash withdrawal reduces money supply — it only changes the form
Trap: Confusing money supply with bank reserves (different concepts)
Trap: Assuming M3 changes when only M1 components shift internally
Common error: Not recognizing that both currency and deposits are parts of the same aggregate
Currency-Deposit Conversion Effects
Indian Economy withdraw cash Demand Deposit Account
Cash Withdrawal Effects: Why Money Supply Stays Unchanged
Cash withdrawal shifts money between forms, doesn't create or destroy it
Demand deposit ↓ by X, Currency in hand ↑ by X = Net effect: Zero
Only credit creation or RBI intervention actually changes total money supply
What Happens During Cash Withdrawal
%%{init: {"flowchart": {"wrappingWidth": 460}}}%%
flowchart TD
s1["`**Initial State**
You have ₹1,00,000 in **demand deposit** + ₹0 cash in hand`"]
s2["`**Withdrawal Action**
You withdraw ₹1,00,000 from your bank account`"]
s3["`**Bank's Books**
Bank reduces your **demand deposit balance** by ₹1,00,000`"]
s4["`**Your Holdings**
You now have ₹0 in account + ₹1,00,000 **currency in hand**`"]
s5["`**Money Supply Impact**
**M1 unchanged**: Currency ↑₹1,00,000, Demand deposits ↓₹1,00,000`"]
s1 --> s2
s2 --> s3
s3 --> s4
s4 --> s5Money Supply Changes vs No Changes
Action | Effect on Money Supply | Reason |
|---|---|---|
Cash withdrawal from account | No change | Converts demand deposit to currency (both in M1) |
Depositing cash in account | No change | Converts currency to demand deposit (both in M1) |
Bank lending (credit creation) | Increases | Creates new demand deposits |
Loan repayment | Decreases | Destroys demand deposits |
RBI buying bonds (OMO) | Increases | Injects new money into system |
Memory aid: Think water between glasses — total water unchanged, just location shifts
Don't confuse with credit creation where banks actually generate new deposits
Key insight: Only RBI or bank lending can change total money supply, not individual withdrawals
Credit Creation & Money Multiplication
Indian Economy
How Banks Actually Create Money: Credit Creation Process
Banks create money through credit creation when they lend
Money multiplier = 1/CRR determines max money creation potential
Fresh deposits enable multiple rounds of lending
Individual cash withdrawals do not trigger money creation/destruction
Why This Matters
Understanding credit creation explains why the PYQ answer is option D. Banks create money when they lend, not when customers withdraw cash. The cash withdrawal question tests whether you confuse money conversion with money creation.
Credit Creation Process
%%{init: {"flowchart": {"wrappingWidth": 460}}}%%
flowchart TD
s1["`**Initial Deposit**
Customer deposits ₹1,00,000 **fresh money** in Bank A`"]
s2["`**Reserve Requirement**
Bank A keeps **CRR portion** (say ₹4,000 at 4% CRR) with RBI`"]
s3["`**Lending**
Bank A lends remaining ₹96,000 to borrower as **new deposit**`"]
s4["`**Re-deposit**
Borrower spends money, it reaches Bank B as new deposit`"]
s5["`**Multiple Rounds**
Process continues: Bank B lends ₹92,160, Bank C lends ₹88,474...`"]
s6["`**Total Creation**
Total money created = ₹1,00,000 × **Money Multiplier (1/CRR)**`"]
s1 --> s2
s2 --> s3
s3 --> s4
s4 --> s5
s5 --> s6Money Creation vs Money Conversion
Scenario | What Happens | Money Supply Effect | UPSC Trap |
|---|---|---|---|
Fresh deposit from outside banking system | Enables credit creation | Multiplied increase | Students may think it's just 1:1 |
Bank grants loan | Creates new demand deposit | Direct increase | May seem like just moving existing money |
Cash withdrawal from account | Converts deposit to currency | No change | Students think money supply falls |
Transfer between accounts | Moves deposits around | No change | May confuse with new money creation |
Key distinction: Creating money (lending) vs converting money (cash withdrawal)
Money multiplier formula: 1/CRR — if CRR is 4%, multiplier is 25
UPSC loves testing: Whether you know the difference between money conversion and money creation
RBI Tools for Money Supply Control
Indian Economy
How RBI Actually Controls Money Supply: Policy Tools
Open Market Operations (OMO) directly inject/withdraw money from system
CRR changes affect money multiplier and lending capacity
Repo/Reverse Repo rates influence cost of borrowing
SLR mandates minimum government securities holding by banks
Context
While individual cash withdrawals don't change money supply, the RBI has powerful tools that do. Understanding these helps distinguish between actions that actually affect aggregate money supply versus those that just redistribute it.
RBI Monetary Policy Instruments
Tool | Mechanism | Money Supply Effect | Current Rate/Level |
|---|---|---|---|
Open Market Operations | RBI buys/sells govt securities | Direct increase/decrease | As needed basis |
Cash Reserve Ratio (CRR) | % of deposits banks must keep with RBI | Changes lending capacity | 4.0% (varies) |
Statutory Liquidity Ratio | % of deposits in govt securities | Affects lendable funds | 18.0% (varies) |
Repo Rate | Rate at which RBI lends to banks | Influences credit demand | 6.5% (varies) |
Reverse Repo Rate | Rate RBI pays on bank deposits | Affects bank lending incentive | 3.35% (varies) |
Money Supply Control Mechanism
# RBI Money Supply Control
## Direct Tools
- Open Market Operations
- Currency Issue
- Government Banking
## Reserve Requirements
- Cash Reserve Ratio
- Statutory Liquidity Ratio
- Incremental CRR
## Interest Rate Tools
- Repo Rate
- Reverse Repo Rate
- Bank Rate
- MSF Rate
## Qualitative Tools
- Credit Guidelines
- Moral Suasion
- Selective Credit ControlTrap: Confusing tools that control money supply with actions that just redistribute it
Remember: Only RBI actions or bank lending actually change total money supply
Current affairs: RBI rate changes are frequently asked — stay updated on policy meetings