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In the United States, the federal funds rate is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight.^[1] Changing the target rate is one form of open market operations that the Chairman of the Federal Reserve uses to regulate the supply of money in the U.S. economy.^[2]

U.S. banks and thrift institutions are obligated by law to maintain certain levels of reserves, either as non-interest-bearing reserves with the Fed or as vault cash. The level of these reserves is determined by the outstanding assets and liabilities of each depository institution, as well as by the Fed itself, but is typically 10% of the total value of the bank's demand accounts.

For example, assume a particular U.S. depository institution, in the normal course of business, issues a loan. This dispenses money and reduces the bank's reserves. If its reserve level falls below the legally required minimum, it must add to its reserves to remain compliant with Federal Reserve regulations. The bank can borrow the requisite funds from another bank that has a surplus in its account with the Fed. The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate.

The nominal rate is a target set by the governors of the Federal Reserve, which they enforce primarily by open market operations. When the media refer to the Federal Reserve "changing interest rates," this nominal rate is almost always what is meant. The actual Fed funds rate generally lies within a range of the target rate, as the Federal Reserve cannot set an exact value through open market operations.

Federal Funds Rate Subcategories Federal Funds Rate Articles Federal Reserve Bank - Controlling Mortgage Interest Rates by Dan Lewis Jan 06, 2006 Homeowners often become very interested in the Federal Reserve Bank system. Every time the board of directors meets, mortgage interest rates are at risk. Federal Reserve Bank The Federal Reserve System acts as the central bank of the ...