What is the Federal Funds Rate?

The Fed Funds Rate is the interest rate on the US interbank market. The most important is the overnight call rate. This change in interest rates can sensitively reflect the remaining funds between banks. The Fed's targeting and adjustment of interbank lending rates can directly affect the cost of funds for commercial banks, and pass the remaining funds in the interbank market to industrial and commercial enterprises, which in turn affects consumption and investment. And the national economy. The most commonly quoted interest rate in the federal funds market is the effective federal funds rate. The Federal Reserve announcement defines the daily effective interest rate as the weighted average interest rate traded through New York brokers. ^[1]

Federal funds rate

The Fed Funds Rate is the interest rate on the US interbank market. The most important is the overnight call rate. This change in interest rates can sensitively reflect the remaining funds between banks. The Fed's targeting and adjustment of interbank lending rates can directly affect the cost of funds for commercial banks, and pass the remaining funds in the interbank market to industrial and commercial enterprises, which in turn affects consumption and investment. And the national economy. The most commonly quoted interest rate in the federal funds market is the effective federal funds rate. The Federal Reserve announcement defines the daily effective interest rate as the weighted average interest rate traded through New York brokers. ^[1]

As the largest participant in the inter-bank lending market, the Fed did not have the ability to adjust the inter-bank lending rate from the beginning, because it can only adjust its own lending rate, so it can determine the federal funds rate of the entire market. The mechanism should be like this. The Federal Reserve lowers its borrowing rate, and the borrowing between commercial banks will shift to that between the commercial bank and the Federal Reserve. Because the cost of borrowing from the Federal Reserve is low, the entire market's borrowing rate will decline. If the Fed raises the borrowing rate, the federal funds rate itself will be under upward pressure when the market is short of funds, so it must rise with the Fed's borrowing rate. In the case of relatively loose market funds, the Fed raises the lending rate, and commercial banks borrowing from the Fed will turn to other commercial banks, leaving the Fed's lending rate to "stand high". However, the Fed can throw out government bonds on the open market and absorb excess excess reserves from commercial banks, causing tight funds in the interbank lending market, forcing the federal funds rate and the Fed's lending rate to rise simultaneously. Because the Fed has the ability to intervene in market interest rates, and its repeated operations will form reasonable market expectations. As long as the Fed raises its own lending rate, the entire market will smell the wind, and the Fed can directly announce changes in the federal funds rate. As for whether the Fed is to complement it with other operations, it is less important.

Comparatively speaking, changes in the rediscount rate can only affect those commercial banks that require and qualify for rediscount, and then use their excess reserve balance to affect the interbank lending rate, because the commercial banks that can obtain rediscount funds are limited, and from the theory In the past, these funds could not be dismantled for profit, which blocked the expansionary effect of falling rediscount rates. Similarly, with the increase of the discount rate, there may not be many commercial banks that pay back, and the tightness of over-preparation of commercial banks is also relatively limited, and its austerity effect is difficult to fully take effect. In this sense, the Fed's use of the rediscount rate is unavoidable, which is far less effective than directly regulating the federal funds rate.