A central bank can manipulate the total money supplied in an economy by setting a short term interest rate target. To make market rates comply with the target rate, the central bank lends or borrows to/from banks in the open market. 

In a fractional-reserve banking system a bank can use the central bank money to create a multiple amount of that as commercial money. The multiplier is defined by the reserve rate (or capital adequacy ratio) the bank is supposed to hold. The central bank has the authority to set the required reserve rate.

In principal a central bank has thereby two possible means to influence the money supply. It can change the interest rate target and/or it can change the reserve requirement of major banks and thereby the multiplier that transfers central bank money supply into total money supply.

The reserve requirement tool has been weakened in recent years with the Basel accords and in the U.S. other regulatory measures which allow banks to a certain extend to define their effective reserve rate themselves.

Therefore the current ‘western’ mainstream central banks tend to not change the required reserve rate but do rely on interest rate setting to induce changes the total money supply.

If the economy slumps, they lower interest rates to supply more money,
make credit cheaper and allow for more economic expansion. If the
economy runs too hot, creating the danger of inflation, the central
banks increase the interest target rate and thereby lower the money it
supplies through the banking system.

To solely rely on the interest rate target has some problematic
consequences. While a low interest rate may be intended to increase
industrial production, it also lessens the saving rates as saving at
low interest rates becomes unprofitable. Low interest rates encourage
to take on debt. While that can be healthy if a loan is used for
productive activity, buying overvalued unproductive assets or consuming
from debt has negative economic effects.

The Chinese central bank takes a different approach. The Shanghai stock index was around 1,000 in early 2006. It increased
to 6,000 in late 2007. This was obviously a overheating market bubble.
The Chinese central bank pricked the bubble not by changing its
interest rate target as the u.S. Fed would have done, but by increasing
the reserve requirement for the major banks step by step from 7.5% in
June 2006 to over 11.5% in June 2007. The ability of Chinese banks to
make loans to people to buy more overvalued stocks was thereby lowered.
With the usual time delay such measures take, the policy was effective
and at the end of 2007 the overheated Shanghai index started to decline.

I have long thought that the Chinese way may be better in setting
money supply targets because, in my view, it has less negative side
effects. But I have to admit that I am no expert in that field and
should be careful to argue for a dual central bank policy approach of
active use of interest rate targets AND reserve requirement settings.

But the recent market turbulence seems to give the reserve requirement approach some new life.

If central banks decide to again use reserve requirements for
monetary policy such requirements must be binding for all financial
entities including hedge funds and other parts of the shadow banking
system. Via Eurointelligence we learn that some knowledgeable folks start to argue in that direction:

The
report was written by group headed by Otmar Issing, and includes Bill
White, formerly of BIS, Jan Pieter Krahnen of Frankfurt University, as
well Jorg Asmussen, deputy finance minister, and Jens Weidmann,
Merkel’s economic adviser.
…
The most important is that all financial companies, whether banks, hedge funds, or banking departments in companies, have to come under a supervisory umbrella, as do all financial products, including CDS, CDO etc. The Issing group also proposes that each bank should hold capital of at least 5% of all its lending (bringing back the spirit of Basle I into Basle II.

Via Yves Smith the proposal of a Japanese expert:

First, adjust capital adequacy ratios to restrain the lending cycle.
For example, the 4 per cent target for the tier one capital ratio for
banks might be raised to 8 per cent in booms but lowered to 3 per cent
in recessions. Cycle-dependent capital ratios would reduce the tendency of banks to lend too generously in booms and too timidly in recessions.
…
Fourth, impose leverage limits to counter the funding cycle.
In recent years, some financial institutions became overleveraged as a
result of competitive pressures on regulators to lift leverage limits.
Such limits should be reinstated on an internationally consistent
basis. When times are good, the leverage limits should be lowered in
order to prevent overshooting. When times are bad, the limits should be raised in order to spur recovery.

Bush continues his "free market" sham while using $5 trillions to prop up the private
banking system. It is unlikely that he will allow the G20 meeting this
weekend from to be successful and to introduce better regulation and
monetary instruments.

But as the problems induced by adverse effects from interest rate
target setting continue to haunt people, the reintroduction of reserve
requirements as a monetary tool is likely to gain favor.

Could Obama  find a Secretary of Treasury who supports such a policy?