Federal Funds Rate (Fed Funds Rate)

Definition

The term federal funds rate refers to the rate of interest charged when financial institutions borrow funds from one another to meet their reserve requirement. The actual federal funds rate is a weighted average of all the transactions conducted by these banks.

Explanation

Also known as fed funds, federal reserve funds represent overnight borrowing between banks held by the Federal Reserve and necessary to meet their reserve requirements. If a depository institution has excess reserves, it is permitted to lend those funds to institutions that have a reserve deficiency. Typically, these unsecured loans are made for exactly one day and that is why they are sometimes referred to as overnight loans.

Also known as the fed funds rate, the interest rate on these loans is frequently used as an indicator of interest rate direction. The Federal Reserve Bank sets the interest rate on overnight borrowing and these rates are one of the levers the Federal Reserve uses to control both the supply of money (via the reserve requirement) and interest rates (via the fed funds rate).

The federal funds rate tracks closely with other short-term interest rates such as LIBOR. The rate is typically published by the Federal Reserve and is a weighted average of the transactions occurring on the market that same day.

Related Terms

open market operations, reserve requirement, monetary policy, contractionary monetary policy, expansionary monetary policy, fiscal policy