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2 Quick Points to Simplify the Federal Funds Rate
An important rate that influences the economy
The federal funds rate is a target interest rate set by the Federal Open Market Committee (FOMC), a committee charged with overseeing the nation’s open market operations. The rate determines what banks and other depository institutions can lend money to each other at, typically on an overnight basis.
It is important to note that the FOMC sets the target for the federal funds rate 8 times a year based on current and forecasted economic conditions. Whether people are aware of it or not, the federal funds rate is an important interest rate that can influence the economy directly and indirectly. 2 quick points to further simplify understanding the federal funds rate are as followed:
1. The Federal Funds Rate and Banks Lending to Each Other
2. The Federal Funds Rate Influence on the Prime Lending Rate and Stock Market
1. The Federal Funds Rate and Banks Lending to Each Other
As stated earlier, the federal funds rate determines what banks and other depository institutions can lend money to each other at, typically on an overnight basis. It is important to note that depository institutions are required to maintain a reserve equal to a certain percentage of their deposits in an account at a Federal Reserve bank, known as a reserve requirement. Any money that depository institutions have above that requirement can be used to lend to another institution that might be close to falling under their reserve requirement.
When it comes to the federal reserve rate and a bank lending to another bank that is close to falling under their reserve requirement, the FOMC cannot force that bank to charge the exact federal funds rate. Since the federal funds rate is only a target, the actual interest rate a bank will charge another bank is determined through negotiations. In the case to assist in making sure fair interest rates are charged, the FOMC has the power to adjust the money supply by lowering reserve requirements.
2. The Federal Funds Rate Influence on the Prime Lending Rate and Stock Market
The more relatable part of this article to you and me is how the federal funds rate…
