UPSC Prelims 2020 Q50: Indian Economy – Monetary Policy & Money Supply
- (a) to reduce it by 8 1,00,000
- (b) to increase it by 8 1,00,000
- (c) to increase it by more than 8 1,00,000
- (d) to leave it unchanged
Answer: (d) to leave it unchanged
Explanation
Demand Deposit Withdrawal: Impact on Money Supply
Effect on aggregate M?
| Reduce by withdrawal amount | NO - conversion, not elimination |
|---|---|
| Increase by withdrawal amount | NO - opposite |
| Increase by more than amount | NO - only conversion |
| Leave unchanged | YES |
Withdrawal of Rs 1,00,000 from checking account:
- Bank's deposits down by Rs 1,00,000
- Currency in circulation up by Rs 1,00,000
- M1 (currency + demand deposits) remains unchanged
- M2/M3 unchanged (components rearranged, total same)
Money supply M = C + D (currency + deposits). Withdrawal converts D -> C; total unchanged. Multiplier effect only when money LEAVES banking system (deposited elsewhere irrelevant).
Answer: (d) leave it unchanged.
Why each option is right or wrong
- (a) Incorrect. Conversion not elimination - money still in system.
- (b) Incorrect. Withdrawal doesn't add to money supply.
- (c) Incorrect. No multiplier effect on aggregate M.
- (d) CORRECT. Withdrawal converts demand deposits to currency; M aggregate unchanged.
Key point
Money supply definition: M = C + D. Withdrawal moves money from D to C component; total M unchanged. Multiplier effects only when money exits banking system entirely.
Remember
When withdrawing Rs 1,00,000 cash from a Demand Deposit Account, the immediate effect on aggregate money supply in the economy will be to LEAVE IT UNCHANGED - cash in circulation increases by the same amount deposits decrease, so M1 remains constant.
Common mistakes
- Confusing withdrawal with loss. Money doesn't disappear; just changes form.
- Assuming each transaction affects money supply. Only bank lending/borrowing changes M.
- Missing that the multiplier works on net lending, not on internal transfers.
Exam tip
Money supply mechanics: Bank makes loan -> new deposit created (M rises). Depositor withdraws -> deposit shrinks (M falls). But withdrawal converting D to C doesn't change M. Economics curriculum standard example.
Sources
- NCERT Class XII Macroeconomics - Chapter 3: Money and Banking
- Mishkin - Economics of Money, Banking and Financial Markets