Federal funds rate

Federal funds rate
U.S. Bureau of Labor Statistics, Board of Governors of the Federal Reserve Syste · Public domain · source
Name	Federal funds rate
Issuer	United States Federal Reserve
Country	United States
Used by	United States
Borrowing tool	Overnight unsecured lending between depository institutions
Target setter	Federal Open Market Committee
Established	1913

Federal funds rate The Federal funds rate is the overnight interest rate at which depository institutions in the United States lend reserve balances to one another. It is the operational focus of monetary policy conducted by the United States Federal Reserve, set through actions by the Federal Open Market Committee and implemented via operations in money markets and interactions with fiscal institutions such as the United States Department of the Treasury. Changes in the rate influence global finance, affecting asset prices in centers like New York City, London, and Tokyo and interacting with policy decisions of other central banks such as the European Central Bank, the Bank of England, and the Bank of Japan.

Definition and mechanics

The Federal funds rate refers specifically to the rate on uninsured, unsecured overnight loans of reserve balances held at the Federal Reserve Bank among depository institutions including commercial banks, savings and loan associations, and credit unions. Institutions manage reserve positions to meet requirements established under statutes like the Federal Reserve Act and to comply with supervisory guidance from the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation. The Federal Open Market Committee sets a target range or target level, which is operationalized through open market operations conducted by the New York Fed trading desk, standing facilities such as the discount window, and administered rates including interest on excess reserves (IOER) and the overnight reverse repurchase operations (ON RRP) offered to eligible counterparties like Ginnie Mae-linked institutions and primary dealers.

Historical evolution

The role and prominence of the Federal funds rate evolved from the creation of the Federal Reserve System in 1913 and the development of interbank reserve management through the Great Depression and the Banking Act of 1935. During the Bretton Woods Conference era and the subsequent collapse of fixed exchange rates in 1971, the Federal Reserve shifted tools and targets, confronting episodes of high inflation in the late 1970s and early 1980s under Chairmen including Paul Volcker and Alan Greenspan. The crisis episodes of the early 21st century—such as the Dot-com bubble aftermath, the Global Financial Crisis of 2007–2008, and the COVID-19 pandemic—saw unconventional policy measures like quantitative easing and interest on excess reserves change how the rate was managed alongside balance sheet expansions under leaders including Ben Bernanke, Janet Yellen, and Jerome Powell.

Determination and policy framework

The Federal Open Market Committee sets the policy stance based on macroeconomic objectives codified in the Federal Reserve Act: maximum employment and stable prices. The FOMC assesses indicators such as the Consumer Price Index, the Personal Consumption Expenditures Price Index, payroll reports from the Bureau of Labor Statistics, and output measures like Gross Domestic Product published by the Bureau of Economic Analysis. Decisions reflect interactions with fiscal conditions influenced by legislation from the United States Congress and fiscal operations of the United States Department of the Treasury. The policy framework incorporates communication strategies like post-meeting statements, minutes, and projections that aim to anchor expectations in markets such as the New York Stock Exchange, the Chicago Mercantile Exchange, and the foreign exchange market.

Economic effects and transmission mechanisms

Adjustments to the Federal funds rate transmit through market rates for instruments including Treasury bills issued by the United States Department of the Treasury, mortgage rates influenced by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, and corporate borrowing costs determined in markets such as the New York Stock Exchange, the NASDAQ, and the Over-the-Counter Market. The transmission operates via bank lending channels involving institutions supervised by the Office of Thrift Supervision (historic) and current prudential regulators, portfolio rebalancing effects affecting asset managers like BlackRock and Vanguard, and expectations channels shaped by investors including sovereign wealth funds and central banks like the People's Bank of China. Effects on employment, investment, and inflation play into targets used by policymakers in macro models influenced by research from institutions such as the National Bureau of Economic Research, the International Monetary Fund, and the World Bank.

Measurement, market dynamics, and instruments

Market measures of the effective Federal funds rate are compiled from transaction data that reflect negotiated rates among counterparties including primary dealers, money market funds such as those managed by Fidelity Investments and State Street Corporation, and large commercial banks such as JPMorgan Chase, Bank of America, and Wells Fargo. The New York Fed’s trading desk conducts repos and reverse repos with counterparties including the Federal Home Loan Banks and foreign official accounts of central banks like the Bank of Canada. Instruments used to implement policy include open market operations, the discount window facilities backed by the Federal Reserve Act, interest on excess reserves set at the Board of Governors, and emergency tools applied under statutory authorities such as Section 13(3) during extraordinary disruptions exemplified in coordination with entities like the Treasury Department.

Criticisms and debates

Debate surrounds the optimal rate path and tools, engaging critics from scholars associated with Monetarism, proponents of Keynesian economics, and advocates of rules-based approaches like the Taylor rule. Critics in political forums such as hearings before the United States Congress or commentary by figures from think tanks like the Brookings Institution, the Cato Institute, and the Heritage Foundation argue about distributional effects on savers and borrowers, financial stability implications noted by regulators including the Financial Stability Oversight Council, and the potential for moral hazard highlighted after interventions in episodes like the Global Financial Crisis. Academic disputes involve researchers publishing in journals like the American Economic Review and presentations at conferences organized by the American Economic Association.

Notable rate changes and crises

Significant policy episodes include the rapid hikes under Paul Volcker to combat 1970s inflation, the easing cycles after the Dot-com bubble under Alan Greenspan, emergency cuts and facilities introduced during the Global Financial Crisis under Ben Bernanke, and the near-zero target range and balance-sheet expansion during the COVID-19 pandemic under Jerome Powell. Other notable interactions occurred during international shocks such as the 1973 oil crisis, the Asian Financial Crisis, and coordination episodes with institutions like the Bank for International Settlements and the International Monetary Fund to stabilize global markets.

Category:United States monetary policy