Federal Funds Rate

QUOTE AND NEWS
Clusterstock  Mar 23  Comment 
Where will the Fed Funds rate be in 3 years.  The Fed's latest Dot Plot shows that the Fed thinks in three years, which it considers the "longer run," interest rates will be around 3.5%.  But Twitter is quite a bit more dovish.  David...
Market Intelligence Center  Mar 19  Comment 
Markets surged on Wednesday after FOMC’s policy statement indicated federal funds rate would be raised only gradually. The Federal Reserve’s move to eliminate the “patient” phrase from its guidance indicated the central bank edged a step...
MarketWatch  Feb 27  Comment 
The longer-run value of the federal funds rate is 3.5%, well below its historical level of 4.5%, said William Dudley, the president of the New York Fed, on Friday. The longer-run value is where the funds rate would encourage growth without...
Forbes  Feb 3  Comment 
It is generally assumed that a hike in the federal funds rate will cause a commensurate rise in level across the yield curve, but in reality, the yield curve evolution tends to be more flexible and ultimately to dictate returns.




 
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The Federal Funds Rate (FFR) is the interest rate that banks pay to borrow federal funds. Federal law requires that banks hold a certain percentage (typically 10%) of the assets in their demand accounts (checking and savings accounts) with the Federal Reserve. These are referred to as federal funds. If a bank below its minimum federal funds reserve requirement, then it can borrow federal funds from another bank that has a surplus in its account.

How the Fed Funds Rate is Set

The Fed does not set the FFR directly. Instead it sets a nominal or desired rate and then carries out open market operations-- the buying and selling of government or other types of securities to influence money supply. When the fed sells large amounts securities to investors, it takes the proceeds from the sale and holds them, essentially removing money from the market and increasing interest rates. When it buys large amounts of securities, it injects money into the market lowering interest rates.

How the FFR affect banks

Loans involving Federal Funds are typically very short in duration, overnight. These loans are often a necessary part of a banks business. Banks depend on demand accounts for a substantial portion of the funding for the loans that they make. On any given day, a bank may lose more in deposits than it takes in or the demand for its loans may temporarily outstrip the assets that it has available, requiring it to draw upon the assets in its reserve account with the Fed. Borrowing funds from another banks reserve account is an expedient way for the bank to raise capital.

How the FFR affects the general economy

When the Federal Reserve raises the FFR it discourages banks from borrowing Federal Funds and in turn lowers the amount of money that banks are able/willing to lend. This has a broader dampening effect on the economy and can lead to slower economic growth. When the Fed lowers the FFR, it has the opposite effect.

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