The central bank of a country controls the supply of money in the economy. Commercial banks lend out a part of the deposits they receive, and every new loan opens a new deposit. When the central bank wants banks to lend more, it makes funds cheaper and easier for them to get. When it wants them to lend less, it does the opposite. Changes in bank lending change the deposits with banks and hence the money supply in the economy.
In the passage, every new loan opens a new deposit. A borrower keeps a new loan of Rs 10,000 in her current account. Which of the following is correct?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Demand deposits rise, and hence M1 rises.
Money in a current account is a demand deposit. Demand deposits are part of M1 = CU + DD, so M1 rises.
Option (1) Demand deposits rise, and hence M1 rises. — Correct. The new loan sits as a demand deposit.
Option (2) Currency held by the public rises, so high powered money rises. — Incorrect. The borrower holds a deposit, not cash. High powered money is the currency the central bank issues.
Option (3) Post Office deposits rise, so only M4 rises. — Incorrect. The money is in a commercial bank, not a Post Office.
Option (4) Time deposits rise, so M3 rises but M1 does not. — Incorrect. A current account deposit is a demand deposit. M3 contains M1, so both rise.
NCERT (2026-27): “The Supply of Money : Various Measures … Apart from currency notes and coins, the balance in savings, or current account deposits, held by the public in commercial banks is also considered money since cheques drawn on these accounts are used to settle transactions. Such deposits are called demand deposits as they are payable by the bank on demand from the account-holder. Other deposits, e.g. fixed deposits, have a fixed period to maturity and are referred to as time deposits. …” “Legal Definitions: Narrow and Broad Money … M1 = CU + DD |