Final answer:
Depositing money in a bank and the subsequent lending activity increase the money supply due to the fractional-reserve banking system. The initial deposit, followed by loans made from that deposit, multiplies the effect on the money supply as seen in the M1 money supply which includes checkable deposits and currency.
Step-by-step explanation:
When Smith deposits $600 into her checking account at XYZ Bank and Jones receives a loan for $1,200 at the same bank, the money supply in the economy has effectively increased. This is because when Smith deposits currency into a bank, the bank can lend these funds out to borrowers like Jones.
When Jones's loan is issue and potentially deposited back into the banking system, through mechanics similar to the money creation process, the money supply can increase further beyond the initial loan amount. An example to illustrate this would be if Jack's deposits a loan in its checking account at Second National, the money supply increases by an additional figure, say $8.1 million as seen in certain economic models.
The increase in the money supply occurs because of the fractional-reserve banking system where banks are required to hold only a portion of their deposits in reserve and can loan out the remainder. This system allows for the multiplication of bank deposits and thereby increases the M1 money supply.
The M1 money supply includes checkable deposits and currency, which are mediums of exchange that can be used to buy goods and services. Once loans are made and deposited into checking accounts, they contribute to increasing the overall money supply.