Federal Reserve funds rate (federal funds rate)

Definition

The Federal Reserve funds rate (federal funds rate) is the interest rate at which depository institutions lend reserve balances to other depository institutions overnight. It is a crucial tool used by the Federal Reserve to control monetary policy and influence economic activity.

5 Must Know Facts For Your Next Test

1. 1. The federal funds rate influences the interest rates on bonds, including Treasury and corporate bonds.
2. 2. Changes in the federal funds rate can affect bond prices inversely; when rates go up, bond prices typically go down.
3. 3. The target range for the federal funds rate is set by the Federal Open Market Committee (FOMC).
4. 4. A lower federal funds rate can stimulate economic growth by making borrowing cheaper, which in turn can affect bond yields.
5. 5. The effective federal funds rate is determined by the market but influenced heavily by the Federal Reserve's open market operations.

Review Questions

• 1. How does an increase in the federal funds rate generally affect bond prices?
• 2. Who sets the target range for the federal funds rate?
• 3. Why might a lower federal funds rate lead to decreased yields on newly issued bonds?

Related terms

Monetary Policy: Actions taken by a central bank to manage interest rates and money supply to achieve macroeconomic goals

Bond Yield: The return an investor realizes on a bond, often influenced by prevailing interest rates

Open Market Operations: Activities by a central bank to buy or sell government securities in the open market to regulate money supply