federal funds rate

Examples of federal funds rate in the following topics:

• The Federal Funds Rate

  • The Federal Funds rate is the interest rate at which depository institutions actively trade balances held at the Federal Reserve.
  • The Federal Funds rate (or fed funds rate) is the interest rate at which depository institutions (primarily banks) actively trade balances held at the Federal Reserve.
  • The Federal Funds rate is directly related to the interest rate paid by firms and individuals.
  • A high Federal Funds rate, therefore, has a contractionary effect on economic activity, while a low Federal Funds rate has an expansionary effect.
  • The graph shows the federal funds rate for the past fifty years.

• The Discount Rate

  • The rate that member banks charge each other is the federal funds rate and the rate the Fed charges is referred to as the discount rate.
  • The interest rate is an active target and is set as a target rate range by the Fed; it is conveyed to the public by the Federal Reserve Open Market Committee (FOMC) as the fed funds target rate (short for the Federal Funds rate).
  • The rate that member banks charge each other is referred to as the federal funds rate and the rate the Fed charges banks is referred to as the discount rate.
  • The Fed targets the rate for federal funds via its open market operations and seeks to be the lender of last resort by charging banks a higher rate than the federal funds rate .
  • For example, the difference or spread of the primary credit rate (rate to member banks in solid financial standing) over the FOMC's target federal funds rate was initially 1 percent.

• The Federal Open Market Committee and the Role of the Fed

  • The Federal Open Market Committee is responsible for conducting open market operations in order to achieve a target interest rate.
  • When conducting monetary policy the Fed sets a target for the federal funds rate, which it attempts to achieve using open market operations.
  • To lower the federal funds rate, for example, the Fed buys securities on the open market, increasing the money supply.
  • In order to raise the federal funds rate, on the other hand, the Fed sells securities and thereby reduces the money supply.
  • Imagine the Fed is targeting a federal funds rate of 3%.

• Factors External to the Firm

  • Corporate tax is federal, state, and sometimes local taxes levied on the income of entities treated as a corporation.
  • The Federal Reserve (Fed) is the central banking system of the United States.
  • It is able to accomplish this by targeting the federal funds rate.
  • This is the rate that banks charge each other for overnight loans of federal funds, which are the reserves held by banks at the Fed.
  • Therefore, the Fed tries to align the effective federal funds rate with the targeted rate by adding or subtracting from the money supply through open market operations.

• Setting and Achieving the Interest Rate Target

  • The rate that Fed member banks charge one another is referred to as the Federal Funds rate, or Fed Funds rate for short (rate for funds held at the Fed).
  • It is important to note that the Fed does not set the fed funds target rate, it only issues a range that it targets through active management of the money supply.
  • This in turn impacts the rate that Fed member banks are willing to charge each other for overnight loans, or the Fed Funds rate.
  • The graphic depicts the movement in the effective federal funds target rate.
  • Describe the way in which the Federal Reserve targets the interest rate

• Discount Policy

  • Consequently, the interest rate for federal funds fall and both the monetary base and money supply expand.
  • Figure 4 shows the Federal Funds Market.
  • On the other hand, if the federal funds rate rises, the public believes the Fed is using contractionary monetary policy.
  • As you know from this chapter, the Fed cannot control the federal funds rate, but can only influence it.
  • Other factors can cause the Federal Funds rate to rise or fall.

• The Discount Rate

  • Seasonal credit is extended to relatively small depository institutions that have recurring intra-year fluctuations in funding needs, such as banks in agricultural or seasonal resort communities.
  • The discount rate charged for primary credit (the primary credit rate) is set above the usual level of short-term market interest rates.
  • (Because primary credit is the Federal Reserve's main discount window program, the Federal Reserve, at times, uses the term "discount rate" to mean the primary credit rate. ) The discount rate on secondary credit is above the rate on primary credit.
  • The discount rate for seasonal credit is an average of selected market rates.
  • Discount rates are established by each reserve bank's board of directors, subject to the review and determination of the Federal Reserve System's Board of Governors.

• Executing Expansionary Monetary Policy

  • These loans take place in a private financial market called the federal funds market.
  • The interest rate on the overnight borrowing of reserves is called the Federal Funds rate or simply the "fed funds rate."
  • For example, if the supply of reserves in the fed funds market is greater than the demand, then the funds rate falls, and if the supply of reserves is less than the demand, the funds rate rises.
  • The bank can lend these unneeded reserves to another bank in the federal funds market.
  • Thus, the Fed's open market purchase increased the supply of reserves (money) to the banking system, and the federal funds rate (interest rate) falls.

• The Reserve Requirement

  • Nonetheless, reserve requirements play a useful role in the conduct of open market operations by helping to ensure a predictable demand for Federal Reserve balances and thus enhancing the Federal Reserve's control over the federal funds rate.
  • The cost is equal to the amount of forgone interest on these funds—or at least on the portion of these funds that depository institutions hold only because of legal requirements and not to meet their customers' needs.
  • Unless it is accompanied by an increase in the supply of Federal Reserve balances, an increase in reserve requirements (through an increase in the required reserve ratio, for example) reduces excess reserves, induces a contraction in bank credit and deposit levels, and raises interest rates.
  • It also pushes up bank funding costs by increasing the amount of non-interest-bearing assets that must be held in reserve.
  • Conversely, a decrease in reserve requirements, unless accompanied by a reduction in Federal Reserve balances, initially leaves depository institutions with excess reserves, which can encourage an expansion of bank credit and deposit levels and reduce interest rates.

• Open Market Operations

  • These include the discount rate, the fed funds target rate, and the reserve requirement, and open market operations (OMOs).
  • Historically, the Federal Reserve has used OMOs to adjust the supply of reserve balances so as to keep the federal funds rate--the interest rate at which depository institutions lend reserve balances to other depository institutions overnight--around the target established by the FOMC.
  • The interest rate targeted through the OMO manipulation of the money supply is the fed funds target rate or the rate that member Fed banks charge one another for overnight loans.
  • The target rate is important monetary tool from the perspective that the higher the fed funds rate relative to the return on loanable funds, the greater the incentive for banks to meet their reserve requirement (the bank will lose money) thereby placing limits on the growth of the money supply through the loanable funds market.
  • In addition to this direct interest rate channel, the fed funds rate influences many other interest rates in the economy and by so doing contributed to either incentivizing borrowing for growth or disincentivizing the same.