How does a cash deposit change the M1 measure of the money supply?

Question

The question asks what is the immediate effect of the cash deposit on the M1 measure of money supply. The official answer is "There is no change in the M1 measure of the money supply. (Demand deposits increase by the same amount that cash holdings fall.)." However, I think the some of the money deposited into the bank will be lend out and deposit into other banks and so on. So the multiplier also applies here, so the money supply should increase by the multiplier times the cash deposited minus the cash deposited(minus because cash holding has decreased). Why is that not true?Please suggests if anything is not clear.My guess: maybe it is because the question asks "immediate" effect and hence does not include the process of money being lend out again etc.?

Answer 1

Hi,

Your intuition is perfect. At the moment the cash is deposited into the bank cash holdings fall and demand deposits increase by the same amount. Since both are part of M1, the effects exactly offset each other.

Over time the process you described would incur and eventually M1 could increase by a maximum of:

money multiplier*original change in demand deposits.