CREATE DATABASE actually works by copying an existing database. By default, it copies the standard system database named template1. Thus that database is the "template" from which new databases are made. If you add objects to template1, these objects will be copied into subsequently created user databases. This behavior allows site-local modifications to the standard set of objects in databases. For example, if you install the procedural language PL/pgSQL in template1, it will automatically be available in user databases without any extra action being taken when those databases are made.
There is a second standard system database named template0. This database contains the same data as the initial contents of template1, that is, only the standard objects predefined by your version of PostgreSQL. template0 should never be changed after initdb. By instructing CREATE DATABASE to copy template0 instead of template1, you can create a "virgin" user database that contains none of the site-local additions in template1. This is particularly handy when restoring a pg_dump dump: the dump script should be restored in a virgin database to ensure that one recreates the correct contents of the dumped database, without any conflicts with objects that might have been added to template1 later on.
Another common reason for copying template0 instead of template1 is that new encoding and locale settings can be specified when copying template0, whereas a copy of template1 must use the same settings it does. This is because template1 might contain encoding-specific or locale-specific data, while template0 is known not to.
To create a database by copying template0, use:
CREATE DATABASE dbname TEMPLATE template0;
from the SQL environment, or:
createdb -T template0 dbname
from the shell.
It is possible to create additional template databases, and indeed one can copy any database in a cluster by specifying its name as the template for CREATE DATABASE. It is important to understand, however, that this is not (yet) intended as a general-purpose "COPY DATABASE" facility. The principal limitation is that no other sessions can be connected to the source database while it is being copied. CREATE DATABASE will fail if any other connection exists when it starts; otherwise, new connections to the source database are locked out until CREATE DATABASE completes.
Two useful flags exist in pg_database for each database: the columns datistemplate and datallowconn. datistemplate can be set to indicate that a database is intended as a template for CREATE DATABASE. If this flag is set, the database can be cloned by any user with CREATEDB privileges; if it is not set, only superusers and the owner of the database can clone it. If datallowconn is false, then no new connections to that database will be allowed (but existing sessions are not killed simply by setting the flag false). The template0 database is normally marked datallowconn = false to prevent modification of it. Both template0 and template1 should always be marked with datistemplate = true.
Note: template1 and template0 do not have any special status beyond the fact that the name template1 is the default source database name for CREATE DATABASE. For example, one could drop template1 and recreate it from template0 without any ill effects. This course of action might be advisable if one has carelessly added a bunch of junk in template1. (To delete template1, it must have pg_database.datistemplate = false.)
The postgres database is also created when a database cluster is initialized. This database is meant as a default database for users and applications to connect to. It is simply a copy of template1 and can be dropped and recreated if required.