Federal Funds Rate Definition

See Also:
Interest Rate Swaps
LIBOR
Interest Rate Definition
Interest Rate Risk
Prime Lending Rate
Libor versus Prime Rate
Interest Rate in Selecting Loan

Federal Funds Rate Definition

The federal funds rate definition, or fed funds rate, is the target interest rate for overnight lending and borrowing transactions between banks. The Federals Open-Market Committee (FOMC) sets the US fed funds rate. FOMC is a committee within the central bank of the United States. (For current and historic fed funds rates see the links below).

The fed funds rate is a macroeconomic indicator, closely watched by economists. It is also a central bank monetary policy tool used to influence the nation’s money supply. Use the rate as a reference rate for the US Prime Rate.

Commercial banks and other depository institutions maintain required reserves of capital at district Federal Reserve banks. Furthermore, the fed funds rate technically refers to the rate at which these institutions lend their Federal Reserve account balances to other institutions for short-term or overnight loans.

Federal Reserve Interest Rate Changes

The FOMC meets eight times per year – approximately every six weeks. At these meetings the committee discusses, among other things, the possibility of changing the fed funds rate. Additionally, the actual market rates may differ from the fed funds target rate. However, the target rate is set with the expectation that market rates will conform to the target rate.

The FOMC can lower the fed funds rate. This is typically done to stimulate the economy. The idea is that lower interest rates will encourage lending and borrowing and stimulate economic activity. Increased lending and borrowing also increases the nation’s money supply. Thus, an increased money supply can spur inflation.

The FOMC can increase the fed funds rate. They do this to reduce inflation or slow transactions growth. The idea is that higher interest rates will discourage lending and borrowing transactions. Less lending and borrowing can dampen economic growth. Therefore, this will reduce the money supply and reduce inflation.

Federal Open Market Committee

The Federal Open-Market Committee is a committee within the US Federal Reserve System, the US central bank. This committee is responsible for, among other things, setting the federal funds target rate.

Federal Funds Rate – Prime Rate

Use the fed funds rate as a reference for setting the US Prime Rate. The US Prime Rate is typically set at 300 basis points (or three percentage points) above the fed funds rate. For instance, if the fed funds rate is 2%, then the Prime Rate would be 5%.

Current Fed Funds Rate

To see the current and recent fed funds target interest rates, to go: www.bankrate.com.

Historic Fed Funds Rate

To see historic fed funds target interest rates, to go: www.newyorkfed.org.

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