Federal Funds Rate

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DEFINITION of 'Federal Funds Rate'

The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. The federal funds rate is generally only applicable to the most creditworthy institutions when they borrow and lend overnight funds to each other. The federal funds rate is one of the most influential interest rates in the U.S. economy, since it affects monetary and financial conditions, which in turn have a bearing on key aspects of the broad economy including employment, growth and inflation. The Federal Open Market Committee (FOMC), which is the Federal Reserve’s primary monetary policymaking body, telegraphs its desired target for the federal funds rate through open market operations. Also known as the “fed funds rate".
 

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BREAKING DOWN 'Federal Funds Rate'

The higher the federal funds rate, the more expensive it is to borrow money. Since it is only applicable to very creditworthy institutions for extremely short-term (overnight) loans, the federal funds rate can be viewed as the base rate that determines the level of all other interest rates in the U.S. economy.
 
Banks and other depository institutions maintain accounts at the Federal Reserve to make payments for themselves or on behalf of their customers. The end-of-the-day balances in these accounts are used to meet the reserve requirements mandated by the Federal Reserve. If a depository institution expects to have a larger end-of-day balance than it needs, it will lend the excess amount to an institution that expects to have a shortfall in its own balance. The federal funds rate thus represents the interest rate charged by the lending institution.
 
The target for the federal funds rate – which as noted earlier is set by the FOMC – has varied widely over the years in response to prevailing economic conditions. While it was as high as 20% in the inflationary early 1980s, the rate has declined steadily since then. The FOMC has maintained the target range for the federal funds rate at a record low of 0% to 0.25%, from December 2008 onward, to combat the Great Recession of 2008-09 and stimulate the U.S. economy.
 

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RELATED FAQS
  1. How does the stock market react to changes in the Federal Funds Rate?

    The stock market reacts to changes in the federal funds rate in various ways depending on where it is in the business cycle. ... Read Full Answer >>
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  3. What is stress testing in Value at Risk (VaR)?

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    Interest rates are indirectly affected by open market operations (OMOs). OMOs are a tool in monetary policy allowing a central ... Read Full Answer >>
  5. How do open market operations affect the money supply of an economy?

    The open market operations conducted by the Federal Reserve affect the money supply of an economy through the buying and ... Read Full Answer >>
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    A bond's coupon rate is directly affected by national interest rates, and consequently, so is its market price. Newly issued ... Read Full Answer >>
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    The Federal Reserve impacts a bank's profitability with its influence on interest rates and the money supply. The discount ... Read Full Answer >>
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    The banking sector's profitability increases with interest rate hikes. Institutions in the banking sector such as retail ... Read Full Answer >>
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    The most important interest rates in the economy are the Federal funds rate and the discount rate. The Federal funds rate ... Read Full Answer >>
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