By changing the reserve requirement, the Fed allows banks to create more loans because they don’t have to keep so much on hand in the vault. When banks issue loans, they literally create money “out of thin air.” I won’t attempt to explain this now, as it can be complicated (at least for me). Here are some links though:

When the reserve requirement ratio (RRR) increases, banks loan less, and the money supply decrease, and vice versa. This is used very rarely because it is so powerful due to the money multiplier effect. I think the last time it was used was in the early 1990s, when the Fed lowered the RRR from 12% to 10% in order to bring economy out of recession.

The second tool used by the Fed is to change the discount rate, the interest rate at which the Fed lends money to insured depository institutions. When the discount rate increase, banks borrow less, and therefore the money supply decrease, and vice versa. This isn’t as important as it used to be because banks can now borrow more easily from each other or find other funds if they are in financial trouble. Borrowing from the fed is usually a last resort.

The third and most important tool of the Fed is open market operations. This is the buying and selling of Treasury bills. When the Fed buys securities, it pays out currency for those T-bills, thus increasing money supply. When they sell them, they rein in the money supply. This tool is used almost daily.

Hoped that helped.

..thus increasing inflationary concerns…..