fed funds rate

Examples of fed funds rate in the following topics:

• Setting and Achieving the Interest Rate Target

  • Banks can seek to borrow from other banks holding funds at the Fed.
  • 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 fed funds rate will be within the range of the target; if not the Fed will adjust its open market operations (buying and selling of bonds) to achieve the range .

• 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).
  • However, the rate that the central bank actually cares about is the fed funds 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 .
  • The discount rate is higher than the fed funds target rate and the variance serves as a disincentive for banks to seek funds or short-term borrowings from the Fed.

• 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.

• Executing Expansionary Monetary Policy

  • 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.
  • At a lower fed funds rate, banks are more likely to increase loans, thereby expanding investment activity (in factories, for example, not financial instruments) and promoting economic growth.
  • Expansionary monetary policy will seek to reduce the fed funds target rate (a range).
  • 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 Federal Funds Rate

  • 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 Fed doesn't control the Federal Funds rate directly - it is negotiated between borrowing and lending banks - but it does set a target interest rate and uses open market operations in order to achieve that rate.
  • Influencing the Federal Funds rate is the primary monetary policy tool that the Fed uses to achieve its dual mandate of stable prices and low unemployment.

• Executing Restrictive Monetary Policy

  • 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.
  • At higher fed funds rates, banks are more likely to limit borrowing and their provision of loanable funds, thereby decreasing access to loanable funds and reducing economic growth.
  • 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.

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

  • 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%.
  • If there is an increased demand for money and the Fed takes no action, interest rates will rise.

• Money in the U.S. Economy

  • "The Fed," as it is commonly known, includes 12 regional Federal Reserve Banks and 25 Federal Reserve Bank branches.
  • The rate on such loans, known as the "federal funds rate," is a key gauge of how "tight" or "loose" monetary policy is at a given moment.
  • The Fed's third tool is the discount rate, or the interest rate that commercial banks pay to borrow funds from Reserve Banks.
  • By raising or lowering the discount rate, the Fed can promote or discourage borrowing and thus alter the amount of revenue available to banks for making loans.
  • Further complicating the Fed's task, changes in the money supply affect the economy only after a lag of uncertain duration.

• The Federal Reserve and the Financial Crisis of 2008

  • The Federal Reserve (the Fed) did engage in these types of conventional operations in 2007 and 2008, cutting the target federal funds rate and the discount rate seven times.
  • Normally, a low federal funds rate would encourage banks to borrow money in order to lend it out to firms and individuals, stimulating the economy, but in the aftermath of the financial crisis the Fed was unable to lower interest rates enough to successfully induce banks to make loans.
  • However, following the crisis, the U.S. experienced very low levels of inflation, and cutting the federal funds rate failed to provide enough economic stimulus to get the country out of the recession.
  • Unable to create interest rates low enough to encourage banks to resume lending money, the Fed turned to other, untried policy tools to encourage economic activity.
  • The Fed says the U.S.

• Volcker Disinflation

  • Paul Volcker is an American economist who was appointed by President Carter in 1979 to be the 12th Chairman of the Federal Reserve of the United States (the Fed).
  • The inflation rate had remained high throughout the 1970s, while the growth rate was slow and the unemployment was high.
  • Volcker raised the federal funds target rate from 11.2% in 1979 to 20% in June of 1981.
  • The unemployment rate became higher than 10% during this time as well.
  • The economy was restored by 1982 as a result of the tight-money policy put in place by the Fed.