Federal Funds Rate


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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  1. Do interest rates increase during a recession?

    Interest rates rarely increase during a recession. Actually, the opposite tends to happen; as the economy contracts, interest ... Read Full Answer >>
  2. What happens if interest rates increase too quickly?

    When interest rates increase too quickly, it can cause a chain reaction that affects the domestic economy as well as the ... Read Full Answer >>
  3. When was the last time the Federal Reserve hiked interest rates?

    The last time the U.S. Federal Reserve increased the federal funds rate was in June 2006, when the rate was increased from ... Read Full Answer >>
  4. Do lower interest rates increase investment spending?

    Lower Interest rates encourage additional investment spending, which gives the economy a boost in times of slow economic ... Read Full Answer >>
  5. 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 >>
  6. 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 >>
  7. 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 >>
  8. 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 >>
  9. 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 >>
  10. 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 >>
  11. 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 >>
  12. 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 >>
  13. 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 >>
  14. 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 >>
  15. 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 >>
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  17. What are the implications of a low Federal Funds Rate?

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  18. How does the Federal Reserve determine the discount rate?

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