Federal Funds Rate

What is it the federal funds rate?

The federal funds rate is the overnight lending interest rate banks charge one another to borrow money.

You may be wondering, why do banks need to borrow money from each other?

First, let’s look at how banks bring in money. They take in deposits and use a certain percentage of deposits to provide loans to consumers.

Before the 2008 financial crisis and the Great Recession, banks often kept their reserves holdings low. Actually, they sometimes even fell below the minimum required by the Federal Reserve. And when that happened, they had to borrow money overnight from other banks. The market for all of this borrowing and lending between banks is called the federal funds market and its interest rate is known as the federal funds rate.

The federal funds rate provides a tool through which the Fed can affect the economy through open market operations.

Want to dig deeper on monetary policy and the Fed’s role in the economy? Check out our Macroeconomics section on Monetary Policy and the Federal Reserve.