How the Fed actually works

The Fed has three core functions: setting short-term interest rates, supplying bank reserves, and acting as lender of last resort during crises. Since 2008, it has dramatically expanded the third role through "quantitative easing" (QE) and emergency lending facilities. The total assets on the Fed's balance sheet went from $900 billion in 2008 to a peak of $9 trillion in 2022 — a 10× expansion in 14 years.

Run a QE program below. Watch the Fed's balance sheet expand and see exactly which counterparties receive the new money first.

The mechanics, step by step

Step 1. The FOMC announces it will buy $1 trillion of Treasury securities over the next year. The New York Fed's open market desk executes the purchases.

Step 2. The Fed buys only from primary dealers — currently 24 large financial institutions including Goldman Sachs, JPMorgan, Citi, Morgan Stanley, BofA, Deutsche Bank, Barclays, Nomura, and others. These dealers are the only counterparties for open market operations.

Step 3. When a primary dealer sells Treasuries to the Fed, the Fed credits their reserve account at the Fed. The reserves are created on the spot — they didn't exist before. This is what "money printing" actually means: a journal entry adding to a digital ledger.

Step 4. The primary dealer now has cash (reserves) instead of Treasuries. They can lend these reserves to other banks, hold them at the Fed (earning interest on reserve balances, currently ~5%), or redeploy into other assets — corporate bonds, equities, repo lending.

Step 5. The cascading effect: as primary dealers redeploy capital, asset prices across the economy rise. This is intentional — the "wealth effect" channel of monetary policy is supposed to make asset holders feel richer so they spend more. The side effect is that wealth concentrates further toward those who already own assets.

The other channels of Fed money creation

The discount window. Banks can borrow directly from the Fed, posting collateral (loans, securities). Normally small. During crises, it becomes hundreds of billions overnight. Bloomberg's 2011 FOIA win revealed $7.7 trillion in commitments to specific banks during 2007-2010, much of it not disclosed at the time. Top recipients included Citigroup ($2.5T total support), Morgan Stanley ($2.0T), Bank of America ($1.5T), and foreign banks like RBS, UBS, and Dexia receiving hundreds of billions each.

Section 13(3) emergency facilities. The Federal Reserve Act lets the Fed create lending programs for non-banks during "unusual and exigent circumstances." 2008 examples: TALF, AMLF, CPFF. 2020 examples: PMCCF and SMCCF (which directly bought corporate bonds from companies like Apple, AT&T, McDonald's, Walmart — including companies that didn't actually need help), MLF (municipal bonds), MSLP (mid-sized businesses).

FX swap lines. The Fed lends dollars to foreign central banks, who lend them to foreign banks. ECB, BoJ, BoE, SNB get standing access. Other central banks request and sometimes don't get them. During COVID this hit ~$450B outstanding. Functionally, this is the Fed allocating dollar liquidity by political and diplomatic preference.

Reverse repo facility. Money market funds can park up to $2 trillion+ at the Fed, earning interest paid by the Fed itself. This is a relatively new (post-2013) instrument. Functionally, the Fed is now paying private money market funds risk-free interest from its own income.

Is QE counterfeiting?

This is a serious question, not a fringe one. Steel-manning both sides:

The case yes: new money created from nothing, just like counterfeiting. Distributional effect is similar — those who receive new money first benefit at the expense of those holding existing money (the Cantillon effect, covered next lesson). The "asset purchase" framing is somewhat misleading because the assets purchased (Treasuries) are themselves promises against future taxation. Austrian and post-Keynesian economists have made versions of this argument seriously.

The case no: counterfeiting is illegal extraction; QE has explicit statutory authority. Counterfeiters keep the proceeds; the Fed remits its income to Treasury (~$80B/year normally). QE is reversible (the Fed can sell assets back, "QT"). The new "money" is bank reserves, which sit at the Fed and don't directly enter circulation unless banks lend.

Where the analogy fits well: the Cantillon effect is real, large, and documented. QE explicitly inflates asset prices, which transfers purchasing power from people who don't own assets to people who do. Whether you call that "counterfeiting" depends on whether you think procedural legitimacy changes the moral substance of the wealth transfer. A lot of serious economists think the procedural niceties are largely cover.