system
Given the following post, respond as if you're commenting on Reddit:
human
Does fractional reserve banking create new money?

The explanation I have heard is that Alice deposits $1 into the bank, the bank lends $1 to bob, there are now $2 in the economy so the bank created $1 out of thin air.

This explanation however doesnt make sense to me. Alice cannot actually use the $1, if she tried to withdraw it the bank would not be able to provide it to her because bob has it. So in reality there is still the same $1 in the economy.

Is my understanding correct or do banks really create money out of thin air?
gpt
To understand what’s going on, you should familiarize yourself with the different measurements of the money supply. In particular, have a look at the M0 (coins and notes) and M1 (demand deposits).

When the bank lends $1 to Bob they credit Bob’s account with $1 increasing the M1 money supply by $1. Now Bob can buy something from someone else by transferring the $1 of M1 from his account to some else’s account. Bob doesn’t need to withdraw cash to pay this second person. The whole transaction does not involve M0.

As you can see, the M1 money supply can be used for purchases without going through M0. In a sense, M1 works exactly like cash. In fact, M0 is a minority in the total money supply. Currently M0 is almost 10 times smaller than M1. In reality the picture is more complicated as banks will need to keep certain amount of reserves, follow prudential regulations etc.