Federal Funds Rate

AAA

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".
 

INVESTOPEDIA EXPLAINS '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.
 

VIDEO

Loading the player...
RELATED TERMS
  1. Discount Rate

    The interest rate charged to commercial banks and other depository ...
  2. Federal Reserve Bank

    The central bank of the United States and the most powerful financial ...
  3. Term Fed Funds

    Funds that banks borrow from the Federal Reserve for longer than ...
  4. Fed Balance Sheet

    A breakdown of the assets and liabilities held by the Federal ...
  5. Fed Model

    A model thought to be used by the Federal Reserve that hypothesizes ...
  6. Federal Reserve System - FRS

    The central bank of the United States. The Fed, as it is commonly ...
RELATED FAQS
  1. What are the differences between the Federal Funds Rate and LIBOR?

    In macroeconomics, the interest rate plays a crucial role in delivering an equilibrium on the assets market by equating the ... Read Full Answer >>
  2. What is stress testing in Value at Risk (VaR)?

    Stress testing involves running simulations under crises for which a model was not inherently designed to adjust. The purpose ... Read Full Answer >>
  3. How are interest rates related to open market operations?

    Interest rates are indirectly affected by open market operations (OMOs). OMOs are a tool in monetary policy allowing a central ... Read Full Answer >>
  4. 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 >>
  5. How do interest rates affect a bond's coupon rate?

    A bond's coupon rate is directly affected by national interest rates, and consequently, so is its market price. Newly issued ... Read Full Answer >>
  6. Is the prime rate in the US different from the federal funds rate?

    Although the prime rate and the federal funds rate are closely tied to one another, their base rates differ based on market ... Read Full Answer >>
  7. What impact does the Federal Reserve have on a bank's profitability?

    The Federal Reserve impacts a bank's profitability with its influence on interest rates and the money supply. The discount ... Read Full Answer >>
  8. How do interest rate changes affect the profitability of the banking sector?

    The banking sector's profitability increases with interest rate hikes. Institutions in the banking sector such as retail ... Read Full Answer >>
  9. What are the most important interest rates?

    The most important interest rates in the economy are the Federal funds rate and the discount rate. The Federal funds rate ... Read Full Answer >>
  10. What are the implications of a high Federal Funds Rate?

    A high federal funds rate discourages banks from borrowing from one another, which tightens the money supply. Raising the ... Read Full Answer >>
  11. What is the current yield curve and why is it important?

    The yield curve is a graphed line that represents the relationship between short- and long-term interest rates, specifically ... Read Full Answer >>
  12. What are the implications of a low Federal Funds Rate?

    The federal funds rate is the interest rate at which banks borrow reserves from one another. A low federal funds rate implies ... Read Full Answer >>
  13. How does the Federal Reserve determine the discount rate?

    There are several different discount rates offered through the Federal Reserve system. Technically, discount rates are set ... Read Full Answer >>
Related Articles
  1. Economics

    What's the Federal Funds Rate?

    The federal funds rate is the interest rate banks charge each other for overnight loans to meet their reserve requirements.
  2. Economics

    The Federal Reserve

    Few organizations can move the market like the Federal Reserve. As an investor, it's important to understand exactly what the Fed does and how it influences the economy.
  3. Bonds & Fixed Income

    Understanding Interest Rates, Inflation And The Bond Market

    Get to know the relationships that determine a bond's price and its payout.
  4. Insurance

    Consider Prime Rate Funds For More Income

    These funds may give you the reliable stream of income you need when you're retired.
  5. Personal Finance

    How The U.S. Government Formulates Monetary Policy

    Learn about the tools the Fed uses to influence interest rates and general economic conditions.
  6. Options & Futures

    How Interest Rates Affect The U.S. Markets

    Interest rates can have both positive and negative effects on U.S. stocks, bonds and inflation.
  7. Investing Basics

    What Investors Should Know About Interest Rates

    Understanding interest rates helps you answer the fundamental question of where to put your money.
  8. Investing Basics

    Interest Rates And Your Bond Investments

    By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it.
  9. Fundamental Analysis

    Investing Basics: Flight To Quality

    At times of market stress, investors flee from risky assets to investments the safest ones available.
  10. Credit & Loans

    How Interest Rate Cuts Affect Consumers

    Traders rejoice when the Fed drops the rate, but is it good news for all? Find out here.

You May Also Like

Hot Definitions
  1. OsMA

    An abbreviation for Oscillator - Moving Average. OsMA is used in technical analysis to represent the variance between an ...
  2. Investopedia

    One of the best-known sources of financial information on the internet. Investopedia is a resource for investors, consumers ...
  3. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
  4. Killer Bees

    An individual or firm that helps a company fend off a takeover attempt. A killer bee uses defensive strategies to keep an ...
  5. Sin Tax

    A state-sponsored tax that is added to products or services that are seen as vices, such as alcohol, tobacco and gambling. ...
  6. Grandfathered Activities

    Nonbank activities, some of which would normally not be permissible for bank holding companies and foreign banks in the United ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!