The Fed Funds Rate -- short for Federal Funds Rate -- is the short-term
interest rate at which U.S. depository institutions (commercial
banks, savings and loan associations, credit unions, mutual savings
banks, etc.) lend to each other overnight within the Federal Reserve
system (minimum loan amount is $1,000,000.)
In most cases, when economists, academics, investors and central
bankers refer to the Federal Funds Rate, they are actually referring
to the Fed Funds Rate Target.
The U.S. Federal Reserve sets a target for the Federal Funds Rate,
and keeps the rate on target by executing open market operations,
i.e., the buying and selling of U.S. Treasuries, mortgage-backed
and agency securities via repurchase agreements and reverse repurchase
agreements (also known as "repos.") These repo transactions
take place at the Trading Desk inside the Federal Reserve Bank of
New York*.
The Fed sells debt when it wants to drain cash from the banking
system, and buys it when the Fed wants to pump money into the system.
Open market trading with primary dealers is the Fed's main tool
used to manipulate the fed funds rate. The Fed has three other tools
at its disposal it can use to achieve its monetary policy goals:
tweaking bank reserve requirement ratios, modifying the terms associated
with borrowing from the Fed's discount
window and, as of October
1, 2008, adjusting the rate of interest paid to banks that have
required and excess reserve balances on deposit at the Fed[1].
The Fed Funds Target Rate (FFTR) is America's most important
and most influential benchmark interest rate. The FFTR can be described
as the "main" or "key" interest rate for the
United States. The interest rate-setting Federal Open Market Committee
(FOMC) uses the Fed Funds Target Rate as its most potent tool for
regulating the U.S. economy, lowering it when the economy needs
a boost, and raising it when the rate of inflation and/or inflation
expectations are too high.
NB: On December 16, 2008, the FOMC decided to take the unusual
step of setting a target range of 0% - 0.25% for the fed
funds rate, as opposed to setting a simple target. Since the FOMC
can't set short-term rates below zero, it has devised unique and
unorthodox tools it will use to promote economic growth. From a
December 16 press
release:
"...The focus of the Committee's policy going forward
will be to support the functioning of financial markets and stimulate
the economy through open market operations and other measures that
sustain the size of the Federal Reserve's balance sheet at a high
level. As previously announced, over the next few quarters the Federal
Reserve will purchase large quantities of agency debt and mortgage-backed
securities to provide support to the mortgage and housing markets,
and it stands ready to expand its purchases of agency debt and mortgage-backed
securities as conditions warrant. The Committee is also evaluating
the potential benefits of purchasing longer-term Treasury securities.
Early next year, the Federal Reserve will also implement the Term
Asset-Backed Securities Loan Facility to facilitate the extension
of credit to households and small businesses. The Federal Reserve
will continue to consider ways of using its balance sheet to further
support credit markets and economic activity..."
U.S. law requires that depository institutions keep a certain percentage
of their customers' money on reserve at one of the 12 regional Federal
Reserve banks situated in major U.S. cities:
- Atlanta, GA
- Boston, MA
- Chicago, IL
- Cleveland, OH
- Dallas, TX
- Kansas City, MO
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- Minneapolis, MN
- New York City, NY
- Philadelphia, PA
- Richmond, VA
- San Francisco, CA
- St. Louis, MO
|
Banks try to stay as close to the reserve limit as possible without
going under it, lending money back and forth so as to maintain a
reserve level that is both legal and allows banks to maximize profits.
The FFTR is set by the FOMC,
the Fed's 12-member monetary policy body
(7 Fed Governors plus 5 Federal Reserve Bank presidents). The FOMC
convenes regularly scheduled monetary policy meetings eight times
per year, and it is at these meetings that the FOMC decides whether
to raise or lower the FFTR, or leave it unchanged. During times
of economic crisis, the chairman of the Federal Reserve may at any
time convene an emergency FOMC monetary policy meeting and raise
or lower the FFTR, depending on the nature of the crisis.
As America's cardinal short-term interest rate, the FFTR influences
some of the most important market interest rates throughout the
world, including the U.S. Prime
Rate and the Eurodollar
LIBOR rates.
Click Here for a comprehensive
history of the Target Federal
Funds Rate.
The Current Target Range for the
Federal Funds Rate is: 4.50% - 4.75%
The Current U.S. (Fed) Prime Rate is: 7.75%
November 7, 2024: The FOMC
has voted
to lower the
target
range for the fed funds rate to
4.50% - 4.75%.
Therefore, the United States
Prime Rate is now 7.75%
The next FOMC meeting and decision on short-term
interest rates will be on December 18, 2024.
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