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The Federal Reserve controls the size of the money supply primarily by adjusting the amount of currency in circulation and by requiring that banks maintain a specified:

The Federal Reserve controls the size of the money supply primarily by adjusting the amount of currency in circulation and by requiring that banks maintain a specified reserve ratio.

The reserve ratio is the fraction of total checking deposit value that a bank must maintain in currency.

The US uses what is known as a fractional reserve banking system, which allows a bank to lend out a large portion of the money that people deposit into the bank. The fraction of the deposited money that must be kept in reserve is called the reserve ratio. The required reserve ratio in the US has typically been 10%.

There are two types of money in a fractional reserve banking system operating with a central bank (such as the Federal Reserve):

• central bank money -- physical currency
• commercial bank money -- money created through loans

Whereas physical currency forms the fundamental basis of the money supply, the total supply of money can grow to be much larger than the total value of the currency. Since banks are allowed to lend out a portion of the money that has been deposited by their checking customers, such lending effectively creates new money (commercial bank money) in the total money supply. As a borrower deposits the borrowed money into a checking account, the total amount of checking deposits in the system grows by the size of the loan.

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