<p>How is the money supply affected by the level of central bank lending to commercial banks? Could you elaborate a little?</p>
<p>Commercial banks operate on a fractional reserve system. So if the fractional reserve is 10%, then for every $1 that the central bank loans to a commercial bank then there is a possibility of allowing for paper loans in the amount of $10. In practice not all of that $10 will be loaned out, but it certainly will increase the money supply more than the $1 that the central bank lent out; allowing for Schumpeter’s hero, the entrepreneurial innovator, to borrow some money and get to work.</p>
<p>That’s the basic answer.</p>