What happens to the money supply if the currency-deposit ratio increases?

When the currency-deposit ratio increases, it signifies that individuals are holding a larger proportion of their wealth in the form of currency rather than deposits in banks. This behavior has a direct impact on the money supply within the economy.

In basic terms, the money supply, as defined by measures such as M1 or M2, includes both currency in circulation and deposits in banks. When more money is held as currency, less is available for banks to lend out, which effectively reduces the total amount of money that multiplies through the banking system via the money multiplier effect.

As people withdraw more cash and reduce their deposits, banks face a decline in reserves available for creating loans. Consequently, the overall money supply contracts because banks have less capacity to create new money through lending. In essence, an increase in the currency-deposit ratio points to a shift in the way individuals hold their money, subsequently leading to a decrease in the money supply as banks have a diminished ability to create additional money through lending.