Business, Legal & Accounting Glossary
The Federal funds rate is the interest rate at which banks loan each other overnight funds from their balances with the Federal Reserve.
The Federal funds rate is a target rate set by the Federal Reserve for overnight loans between banks. These overnight loans enable banks to maintain enough reserves to meet federal requirements.
The target interest rate doesn’t determine how much it costs to borrow funds overnight; the actual rates are set by the open market. The weighted average of all of these transactions determines the effective rate, which is usually slightly higher than the nominal or target rate.
Because of this relationship between the target and the effective rates, changing the Federal funds rate either encourages or discourages banks from raising capital through borrowing. In this way, the Federal Reserve affects how freely the economy operates.
The Federal Reserve Board has the power to influence the money supply with the purchase and sale of government securities. This is known as open-market operations and is specified by the Federal Open Market Committee (FOMC). The fed funds rate is the rate of interest that bank members charge each other for overnight loans to meet reserve requirements. A target level is explicitly announced by FOMC for the fed funds rate. The fed funds rate is determined by the actions of FOMC based on the goals for monetary policy. The fed funds rate is lowered when the economy is contracting or growing too slowly. Alternately, the fed funds rate will be raised when consumer demands exceed the ability to produce and prices are rising too quickly. The FOMC determines the fed funds rate and the discount rate (typically 100 basis points higher than the Fed funds rate). The fed funds rate is also known as the federal funds rate.
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This glossary post was last updated: 5th August, 2021 | 0 Views.