What is Federal Funds Rate?

The federal funds rate is the interest rate that depository institutions — banks and credit unions — charge one another for overnight loans of reserve balances held at the Federal Reserve. These uncollateralized loans allow institutions to meet reserve requirements and manage daily liquidity. The Federal Open Market Committee (FOMC) sets a target range for the federal funds rate during its eight regularly scheduled meetings each year, using it as the primary instrument of monetary policy.

When the FOMC adjusts the target range, it influences the effective federal funds rate — the volume-weighted median rate of actual overnight transactions — through open market operations conducted by the Federal Reserve Bank of New York. The Fed increases the rate to cool an overheating economy and curb inflation, and decreases it to stimulate borrowing and economic activity during slowdowns.

Although the federal funds rate is an interbank rate not directly offered to consumers, its movement cascades through the entire interest-rate environment. Changes in the federal funds rate immediately affect the prime rate (the base rate banks charge their most creditworthy corporate customers), which in turn drives rates on credit cards, home equity lines of credit, and variable-rate loans. Deposit rates — on savings accounts, money market accounts, and CDs — also broadly track the federal funds rate, though with a lag and with variation across institutions. The federal funds rate is one of the most closely watched economic indicators worldwide because of its direct impact on borrowing costs, asset prices, and currency exchange rates.