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%.

• The Demand for Money

  • In the United States, the Federal Reserve System controls the money supply.
  • The reserves of money are kept in Federal Reserve accounts and U.S. banks.
  • Reserves come from any source including the federal funds market, deposits by the public, and borrowing from the Fed itself.
  • This graph shows the fluctuations in the federal funds rate from 1954-2009.
  • The Federal Reserve implements monetary policy through the federal funds rate.

• 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

• Greenspan Era

  • Alan Greenspan was Chairman of the Federal Reserve from 1987 to 2006.
  • In 2001, Greenspan and the Fed initiated a series of interest cuts that brought the Federal Funds rate down to 3% following the September 11, 2001 terror attacks.
  • The Federal Funds rate continued to drop until it was 1% in 2004.
  • Interest rate funds increased to 5.25% about two years later.
  • Alan Greenspan was the 13th Chairman of the Federal Reserve.

• 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.

• Executing Restrictive 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 "funds rate."
  • For example, if the supply of reserves in the fed funds market is lower than the demand, then the funds rate increases.
  • Restrictive monetary policy will seek to increase the fed funds target rate.
  • The Fed's open market purchase decreases the supply of reserves (money) to the banking system, and the federal funds rate (interest rate) increases.

• 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.

• Financing State and Local Government

  • Taxes are important to federal, state, and local governments.
  • On a state level, taxes fund the school systems, including state universities.
  • On a federal level, taxes are used to fund government activities such as the provision of welfare and transfer payments to redistribute income.
  • State taxes are generally treated as a deductible expense for federal tax computation.
  • Property tax rules and rates vary widely.