What is the Federal Funds Rate?
The Federal Funds Rate is the rate of interest that is employed when affiliated banks lend money to the Federal Reserve of the United States. The rate is normally applied to very short-term loans that are often repaid the same day of issue or the following business day. Excess fund reserves are the source of the funds used to back the short-term loan to the Federal Reserve. Extending quick loans using the Fed Funds Rate differs somewhat from the process of lending funds to the consumer market. First, there is a cap on the amount of funds that the bank may lend to the Federal Reserve. This is determined by the current balance of surplus funds in the possession of the bank on a given day. This provision helps to ensure that the bank is not hindered from conducting business, even for a single business day. Second, there is no qualification process that the Federal Reserve must go through in order to qualify for the short-term loan. It is understood that the loan will be repaid, along with
The federal funds rate is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight. The rate may vary from depository institution to depository institution and from day to day. Why does the Fed increase or decrease the federal funds rate? The Federal Reserve Act specifies that the FOMC should seek “to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.” At each meeting, the FOMC closely examines a number of indicators of current and prospective economic developments. Then, cognizant that its actions affect economic activity with a lag, it must decide whether to alter the federal funds rate. A decrease in the federal funds interest rate stimulates economic growth, but an excessively high level of economic activity can cause inflation pressures to build to a point that ultimately undermines the sustainability of an economic expa
The federal funds rate is the rate that a Federal Reserve District bank charges another bank for the overnight loans needed to meet the reserve requirements. The Fed sets the requirements and is a certain amount of funds reserved against the deposit of their customers. This money is required to be in the vault or in the closest Federal Reserves Bank.
The federal funds rate is then the average interest rate at which banks loan each other money. CNBC may report that Ben Bernake (Federal Reserve Chief) is lowering the federal funds rate by 50 basis points; this refers to the nominal rate set by the Fed. The Fed can only make a suggestion as to what the fed funds rate should be; lenders will use this as a guide but supply and demand factors will drive the true rate. What are the impacts of increasing or decreasing the federal funds rate? The federal funds rate controls the available supply of funds in the market. Raising the federal funds rate makes it more difficult to investors to borrow money and keeps inflation controlled. Tightening the rates has the opposite effect. It allows for more borrowing and economic growth and therefore more inflation. There is a fine line that the Fed must walk to ensure the economy stays in balance.
Depository institutions like banks are required to maintain a certain level of deposits, called reserves, with the Federal Reserve Bank. This ensures that there is money to pay depositors when they want it. The Fed makes this money available to the institutions, which lend it out to each other overnight to cover fluctuating needs for cash. The line on the graph labeled “Federal Funds” represents the rate that banks and other institutions charge each other for these funds. So when the Federal Reserve “changes” its interest rate, what it’s really doing is targeting a different rate and using its power in money markets to influence the banks–it doesn’t have the power to dictate what the banks charge each other, only to influence the going rate.
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