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The federal funds rate is the interest rate at which private depository institutions lend balances (federal funds) at the Federal Reserve to other depository institutions overnight. An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. ...
A financial institution acts as an agent that provides financial services for its clients. ...
Federal Funds transactions redistribute bank reserves. ...
The Federal Reserve System is headquartered in the Eccles Building on Constitution Avenue in Washington, DC. The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. ...
Here is how the system works:
- U.S. banks and thrift institutions are obligated by law to keep certain non-interest-bearing reserves with the Fed (or to keep an equal amount of vault cash, but this imposes risks and costs). The level of these reserves is determined by the outstanding assets and liabilities of each depository institution, as well as by the Fed itself, but is typically 10% of the total value of the bank's demand accounts.
- Example: A particular U.S. depository institution, in the normal course of business, issues a loan, which dispenses money, reducing that bank's reserves. If its reserve level falls below the legally required level, it must add to its reserves to remain compliant with Federal Reserve regulations. The bank will borrow the requisite funds from another bank that has a surplus in its Fed reserves. The interest rate that the first bank will pay to the second bank in return for borrowing the funds is negotiated between the two banks, and the weighted average of this rate across all banks is the effective federal funds rate.
The nominal rate is a target set by the governors of the Federal Reserve, which they enforce primarily by open market operations (usually, the buying and selling of money through repurchase agreements on bonds). When the media refer to the Federal Reserve "changing interest rates," this nominal rate is almost always meant. The target is generally a range, as the Federal Reserve cannot set an exact value through open market operations. The reserve requirement (or required reserve ratio) is a government regulation, that sets the minimum reserves each bank must hold to customer deposits and notes. ...
It has been suggested that this article or section be merged with Current account (banking). ...
Open Market Operations are the means by which central banks control the liquidity of the national currency. ...
Another way banks can borrow funds to keep up their required reserves is by getting a loan from the Federal Reserve itself at the discount rate. These loans are very short term and rare, as they are subject to audit by the Fed and the discount rate is usually higher than the federal funds rate. Confusion between these two kinds of loans often leads to confusion between the federal funds rate and the discount rate. Another difference is that while the Fed cannot set an exact federal funds rate, it can set a specific discount rate. The Federal Reserve System is headquartered in the Eccles Building on Constitution Avenue in Washington, DC. The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. ...
The federal funds rate is decided at Federal Open Market Committee (FOMC) meetings. Depending on their agenda and the economic conditions of the U.S., the FOMC members will either increase, decrease, or leave the rate unchanged. It is possible to infer the market expectations of the FOMC decisions at future meetings from the CBOT (Chicago Board of Trade) Fed Funds futures contracts, and these probabilities are widely reported in the financial media. The Federal Open Market Committee (FOMC), a component of the Federal Reserve System, is charged under U.S. law with overseeing open market operations in the United States, and is the principal tool of US national monetary policy. ...
The Chicago Board of Trade (CBOT) NYSE: BOT, established in 1848, is the worlds oldest futures and options exchange. ...
Historical rates
Historical chart of the effective Federal Funds Rate Description: Historical chart of the U.S. federal funds rate. ...
See also It has been suggested that monetary theory be merged into this article or section. ...
External links - Historical data (since 1954) comparing the US GDP growth rate versus the US Fed Funds Rate - in the form of a chart/graph
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