Macro Monday: Fed Funds Rate (i.e. Interest Rates)
Greetings from Germany all! I appologize for GradMoney being on hiatus for the past week - we had to make an emergency trip here last Tuesday but will be back in America very soon.
While we have been here, there is certianly a lot going on in the stock market, and in the American economy in general. You may have heard that the Federal Reserve recently made an announcement that it will be raising interest rates, or better known as the Fed Funds Rate, into the new year. This will be a topic of discussion for GradMoney over the next few weeks because it is incredibly important to understand as this will impact most of your finances and your lives for the future.
Today on Macro Monday we will introduce the Fed Funds Rate so you will have some reference for the future. As always, you can look for more research on these subjects if you visit Investopedia. You can also click here to watch an awesome video that explains the terms listed below.
What is the Fed Funds Rate?
The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. The federal funds rate is generally only applicable to the most creditworthy institutions when they borrow and lend overnight funds to each other. The federal funds rate is one of the most influential interest rates in the U.S. economy, since it affects monetary and financial conditions, which in turn have a bearing on key aspects of the broad economy including employment, growth and inflation. The Federal Open Market Committee (FOMC), which is the Federal Reserve’s primary monetary policymaking body, telegraphs its desired target for the federal funds rate through open market operations.
What does it mean and why is it important for me to know?
The higher the federal funds rate, the more expensive it is to borrow money. Since it is only applicable to very creditworthy institutions for extremely short-term (overnight) loans, the federal funds rate can be viewed as the base rate that determines the level of all other interest rates in the U.S. economy. Banks and other depository institutions maintain accounts at the Federal Reserve to make payments for themselves or on behalf of their customers. The end-of-the-day balances in these accounts are used to meet the reserve requirements mandated by the Federal Reserve. If a depository institution expects to have a larger end-of-day balance than it needs, it will lend the excess amount to an institution that expects to have a shortfall in its own balance. The federal funds rate thus represents the interest rate charged by the lending institution. The target for the federal funds rate – which as noted earlier is set by the FOMC – has varied widely over the years in response to prevailing economic conditions. While it was as high as 20% in the inflationary early 1980s, the rate has declined steadily since then. The FOMC has maintained the target range for the federal funds rate at a record low of 0% to 0.25%, from December 2008 onward, to combat the Great Recession of 2008-09 and stimulate the U.S. economy.