The federal funds rate is the interest rate at which:

Question

Accepted Answer

Banks lend reserve balances to each other overnight. The federal funds rate is the interest rate at which depository institutions (banks) lend their reserve balances held at the Federal Reserve to other depository institutions on an overnight basis. This rate is determined by supply and demand for reserves in the federal funds market, and the FOMC sets a target range for the federal funds rate as its primary monetary policy instrument.

The rate the Fed charges for discount window loans is the discount rate, which is a different rate set above the federal funds rate target to encourage banks to borrow from each other first. The interest rate on Treasury bonds is the Treasury yield, which is determined in the bond market and influenced by, but distinct from, the federal funds rate. Consumer credit card rates are set by credit card issuers based on their cost of funds, risk assessment, and market conditions - they are much higher than the federal funds rate.

The federal funds rate is the single most important interest rate in the U.S. financial system and is a central concept on the DSST Money and Banking exam. Students should understand how the FOMC targets this rate, how changes in the federal funds rate ripple through to other interest rates (prime rate, mortgage rates, bond yields), and the mechanism the Fed uses to keep the actual rate near its target through open market operations.

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