What is Federal Funds Rate?
Federal Funds Rate is the interest rate at which the different financial institutions lend their finances to each other overnight.
These transactions are famous because they are done overnight and hence they are known as Federal Funds Rate.
The lending institution has a reserve called Federal Funds Reserve and the transaction normally takes place from that account. Also, one more thing that is noticeable is that there are no collaterals involved in the entire transaction. Again the Fed Bank is at the apex and the FOMC takes active participation in the transaction.
What is the Reason for the Fund Transfer
Normally the transfer takes place due to the simple fact that the institution which has surpluses will lend money to the one which is in need of money. That is the whole concept behind Federal Fund Rate.
But the transactions are very huge and it also has an impact on the Money Supply and Demands all over the world.
Applications
This is supposed to be the best way to borrow funds. Interbank transfer is the simplest and the safest method to get money and Federal Fund Rate acts as a catalyst when banks require money. If Federal Rate was absent then banks when in need of money had to go through long procedures of loans and overdrafts. Thus by way of the Federal Funds Rate, the time and cost of the banks are lessened. Money can be obtained at a much faster rate.
What is the Impact of the Federal Rate on the Economy?
The Federal Funds Rate has a great impact on the world economy. Firstly it affects the money supply and demand in the economy. Also, the trade is of international types and thus keeping the supply constant the prices can also be reduced.
It Makes Money Cheaper
So the rate at which money is getting transferred is the most important part of the Federal Funds Rate. This is because the transaction may be happening between two banks but it affects the demand and supply of many other banks as a whole. Therefore it is the duty of the members of FOMC that they keep a regular check on the rate at which these transactions are taking place. The overnight transactions usually take place after the market closes and thus the next day the entire world can see the after-effects of the transactions. The most affected ones are the financial institutions.
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