Economics
Federal Funds
Federal funds refer to the reserves that banks are required to hold with the Federal Reserve. These funds are used to meet the reserve requirements and to settle interbank transactions. The Federal Reserve uses the federal funds rate to influence the overall level of interest rates in the economy.
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7 Key excerpts on "Federal Funds"
eBook - PDF- Kevin D. Hoover(Author)
- 2011(Publication Date)
- Cambridge University Press(Publisher)
Federal Funds lent would exactly match Federal Funds borrowed . They are shown in Table 16.1 in parentheses to emphasize that these transactions remain important even though they must net to zero for the banking system as a whole. 3 Before 1990, time and savings accounts were also subject to reserve requirements, albeit lower ones than transactions accounts. And the transactions accounts of smaller banks are currently subject to a lower (3 percent) reserve requirement than that charged to larger banks (see www.federalreserve .gov/monetarypolicy/reservereq.htm). 16.2 The Federal Reserve and the Banking System 629 F ederal-funds rate R r FF Fed supplies Banks’ deman d Reserves Figure 16.2. The Federal Funds Market. The supply of reserves depends largely on the past open-market operations of the Fed, and is insensitive to the level of the Federal-funds rate. The demand for reserves depends on the opportunity cost to banks of holding them, which is a negative function of the Federal-funds rate: a bank that holds a dollar of reserves loses the interest it could have earned by lending it on the Federal Funds market, but gains not having to go to the market itself to borrow if it finds itself unexpectedly short of reserves. Equilibrium is, naturally, where supply equals demand, and it determines the Federal-funds rate. Federal Funds lending is literally overnight lending – loans made one day are usually repaid the next. The F EDERAL -FUNDS RATE , the rate of interest charged on one of these overnight loans, is the yield on the shortest matu-rity bond (or loan) typically reported. The Federal-funds rate is particularly important because it is the target rate for U.S. monetary policy. 16.2.3 The Mechanics of Monetary Policy To understand how monetary policy works, we must first understand the structure of the market for bank reserves (Federal Funds). In 2008, the Fed began to pay interest on reserves held at Federal Reserve banks.
No longer available |Learn more- (Author)
- 2014(Publication Date)
- White Word Publications(Publisher)
The Federal Funds rate is a short-term interest rate the FOMC focuses on directly. This rate ultimately affects the longer-term interest rates throughout the economy. A summary of the basis and implementation of monetary policy is stated by the Federal Reserve: The Federal Reserve implements U.S. monetary policy by affecting conditions in the market for balances that depository institutions hold at the Federal Reserve Banks...By conducting open market operations, imposing reserve requirements, permitting depository institutions to hold contractual clearing balances, and extending credit through its discount window facility, the Federal Reserve exercises considerable control over the demand for and supply of Federal Reserve balances and the Federal Funds rate. Through its control of the Federal Funds rate, the Federal Reserve is able to foster financial and monetary conditions consistent with its monetary policy objectives. This influences the economy through its effect on the quantity of reserves that banks use to make loans. Policy actions that add reserves to the banking system encourage lending at lower interest rates thus stimulating growth in money, credit, and the economy. Policy actions that absorb reserves work in the opposite direction. The Fed's task is to supply enough reserves to support an adequate amount of money and credit, avoiding the excesses that result in inflation and the shortages that stifle economic growth. Tools There are three main tools of monetary policy that the Federal Reserve uses to influence the amount of reserves in private banks: Tool Description open market operations purchases and sales of U.S. Treasury and federal agency securities— the Federal Reserve's principal tool for implementing monetary policy. The Federal Reserve's objective for open market operat ions has varied over the years.
eBook - ePub- Jack Rabin(Author)
- 2020(Publication Date)
- Routledge(Publisher)
But this focus on the well-being of the national economy doesn’t mean that the Fed ignores regional economic conditions. Extensive regional data and anecdotal information are used, along with statistics that directly measure developments in the regional economy, to fit together a picture of the national economy’s performance. This is one advantage to having regional Federal Reserve Bank Presidents sit on the FOMC: They are in close contact with economic developments in their regions of the country.WHAT ARE THE TOOLS OF MONETARY POLICY?
The Fed can’t control inflation or influence output and employment directly; instead, it affects them indirectly, mainly by raising or lowering short-term interest rates. The Fed affects interest rates mainly through open market operations and the discount rate, and both of these methods work through the market for bank reserves, known as the Federal Funds market.What Are Bank Reserves?
Banks and other depository institutions (for convenience, we’ll refer to all of these as “banks”) are legally required to hold a specific amount of funds in reserve. These funds, which can be used to meet unexpected outflows, are called reserves, and banks keep them as cash in their vaults or as deposits with the Fed. Currently, banks must hold 3–10% of the funds they have in interest-bearing and non-interest-bearing checking accounts as reserves (depending on the dollar amount of such accounts held at each bank).What Is the Federal Funds Market?
From day to day, the amount of reserves a bank has to hold may change as its deposits change. When a bank needs additional reserves on a short-term basis, it can borrow them from other banks that happen to have more reserves than they need. These loans take place in a private financial market called the Federal Funds market.The interest rate on the overnight borrowing of reserves is called the Federal Funds rate or simply the “funds rate.” It adjusts to balance the supply of and demand for reserves. For example, an increase in the amount of reserves supplied to the Federal Funds market causes the funds rate to fall, while a decrease in the supply of reserves raises that rate.
eBook - PDFDo They Walk on Water?
Federal Reserve Chairmen and the Fed
- Leonard J. Santow(Author)
- 2008(Publication Date)
- Praeger(Publisher)
Traditionally, borrowing from the Fed is considered a privilege and not a right, although this distinction is no longer clear cut. Federal Funds rate: The interest rate at which Federal Funds are traded. Rates charged by banks with excess reserves to other banks that need overnight money to meet reserve requirements. The rate tends to fluctuate, but typically by small amounts, since the Fed- eral Reserve has a target rate which is publicly known. Free reserves: Borrowings by banks at the discount window that are subtracted from excess reserves in the banking system. It is a measurement of the ease or tightness of the Fed’s reserve policy. If borrowings are more than excess reserves, this difference is called net borrowed reserves. Monetary policy: Policies that a central bank, such as the Federal Reserve, develop to influence such important items as interest rates, money supply, bank credit expan- sion, prices, real economic growth, employment, and unemployment. Monetary policy is different from fiscal policy, which is carried out primarily through government spending and taxation, and is not a responsibility of the Federal Reserve. Reserve requirement: Federal Reserve rule mandating the financial assets that mem- ber banks must keep in the form of cash and other liquid assets as a percentage of demand deposits and time deposits. The money must be kept in the bank’s own vaults or on deposit with its regional Federal Reserve bank. unions—have access to the discount window. (The Federal Reserve is responsible for establishing the percentage of deposits that must be held by banks as backing for deposits, and the form these reserves must take to meet the mandated reserve- requirement rules of the Federal Reserve.) Discount window policy has not changed frequently, but when it has changed, it can be of considerable importance from a policy point of view. From the mid-1960s until 2003, the basic discount rate frequently was below the prevailing Federal Funds rate.
eBook - PDFFinancial Institutions
Markets and Money
- David S. Kidwell, David W. Blackwell, David A. Whidbee, Richard W. Sias(Authors)
- 2020(Publication Date)
- Wiley(Publisher)
3.2 The Fed’s Influence on Interest Rates 75 additional investment securities. Thus, the deposit expansion stops at $900 billion. At that point, banks back their $900 billion in deposits with $90 billion in reserves and $810 billion in loans and investments. What happens to our analysis if the Fed decides to pay interest on reserves? Fortunately, the logic and analysis are the same, except that for each of the three situations cited (see Exhibit 3.2), the banks will be motivated to hold excess reserves beyond what they would have otherwise held if the Fed paid no interest on reserves. All things being equal, the higher the interest rate paid on reserves, the larger the bank’s excess reserve holdings tend to be. Finally, note that the Fed’s ability to control the money supply, as discussed here, depends on its ability to control the level of reserves and set reserve requirements. Paying interest on reserves provides the Fed with an additional tool to control the level of reserves. 3.2 THE FED’S INFLUENCE ON INTEREST RATES The fed funds interest rate is one of the most closely watched interest rates in the economy. The market for fed funds consists of the borrowing and lending of overnight reserves among large banks and financial institutions on an unsecured basis. In simple terms, the fed funds rate is the interbank lending rate and represents the primary cost of short‐term loanable funds. The rate on these overnight interbank loans is highly volatile: It is not unusual for the rate to fluctuate more than 25 basis points (0.25 percent) on either side of the average level in a day. The fed funds rate is of particular interest because (1) it measures the return on the most liquid of all financial assets (bank reserves), (2) it is closely related to monetary policy, and (3) it directly measures the available reserves in the banking system, which in turn influences commercial banks’ decisions on making loans to consumers, businesses, or other borrowers.
eBook - PDFIntroduction to Finance
Markets, Investments, and Financial Management
- Ronald W. Melicher, Edgar A. Norton(Authors)
- 2020(Publication Date)
- Wiley(Publisher)
One interest rate that the Fed’s FOMC could focus on is the Federal Funds rate, which is the rate on overnight loans from banks with excess reserves to banks that have deficit reserves. Open-market purchases of securities add to bank reserves and increase the money supply. Sales of securities lower reserves and the money supply. However, when the target is the money supply, interest rates may fluctuate widely, because the demand for money may change relative to a specific money supply target. Furthermore, a focus on the money supply might not produce the desired impact on gross domestic product because of changes in the velocity of money, as we saw in Chapter 2. In recent years, the Fed, through its FOMC, has chosen to focus on setting target interest rate levels for the Federal Funds rate as the primary means of carrying out monetary policy. Evidence indi- cates that observed Federal Funds rates track closely with the Fed’s target Federal Funds rates over time. Banks with excess reserves lend to banks that need to borrow funds to meet reserve requirements. Interest rates, such as the Federal Funds rate, reflect the intersection of the demand for reserves and the supply of reserves. Open-market purchases of securities cause the Federal Funds rate to fall, whereas sales of securities cause the rate to rise. Of course, while the FOMC can set targets for Federal Funds rates, actual Federal Funds rates are determined in the market by banks with excess reserves and banks that need to borrow reserves to meet their minimum reserve requirement. The Fed uses its open-market operations to provide liquidity to the banking system in times of emergency and distress. For example, the stock market crash on October 19, 1987, caused concern about a possible economic collapse. The Fed, through FOMC open-market purchases, moved quickly to increase the money supply.
eBook - PDF- Jeff Madura(Author)
- 2020(Publication Date)
- Cengage Learning EMEA(Publisher)
The goal was to stimulate the economy by reducing interest rates to their minimum level in an effort to encourage more borrowing and spending by households and businesses. The Fed main- tained the Federal Funds rate within this range over the 2009–2015 period; other interest rates were also low during this period. When there is evidence of a very strong economy and the potential for inflation, the Fed tends to implement a monetary policy that will increase the Federal Funds rate (and therefore other interest rates as well). Such a policy aims to reduce any inflation- ary pressure that is attributed to excess demand for products and services. Ideally, this Copyright 2021 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 4: Functions of the Fed 77 policy will reduce inflationary pressure without having an adverse effect on the economy. Exhibit 4.3 shows that the Fed has raised the Federal Funds rate by a small amount several times since 2016. FOMC Statement Following the FOMC meeting, the committee issues a clear detailed statement that summarizes its conclusion. In recent years, the FOMC has acknowledged the importance of this statement, which is used (along with other information) by many participants in the financial markets to generate forecasts of the economy. Voting members vote not only on the proper monetary policy but also on the corresponding communication (statement) of that policy to the public. The statement provided by the committee following each meeting is widely publicized in the news media and can be accessed on Federal Reserve websites.
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