What would be the impact on the economy if people start holding more currency in hand and less in deposits?

When people hold more currency in hand and fewer deposits, the currency-deposit ratio (cdr) increases. The money multiplier (m) is mathematically defined as (1 + cdr) / (cdr + rdr), where rdr is the reserve-deposit ratio. Because currency held by the public does not undergo the fractional reserve banking process, it cannot be used by banks to create additional credit or deposits. Consequently, an increase in the currency-deposit ratio leads to a leakage in the credit creation process, which reduces the overall money multiplier. This means that for every unit of the monetary base, the total money supply generated by the banking system will be lower. Therefore, if the public's preference shifts toward cash over bank deposits, the money multiplier will decrease.

Sources

1. [1] Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2.12 Money Creation > p. 59