Posted in Finance, Accounting and Economics Terms, Total Reads: 302
Definition: Federal Funds
Commercial Banks in the US park their excess funds at the Federal Reserve kitty. This is done to ensure decent liquidity in the system and also to ensure availability of easy credit in the market. This can be lent to the commercial banks that are facing a shortage of liquidity. This lending is done at a very low interest rate and is called the federal rate or is termed as the overnight lending rate. This is because the sum is lent generally for overnight purposes. This is similar to the call money option in the Indian Banking system.
This system helps in maintain the daily banking reserve requirements. Every bank has to maintain certain amount of reserves depending on the amount of the deposit that the bank is holding.
Credit becoming tightly available or freely available depends on the availability of cash in the market to borrow in case of a crunch in the money system. In case the credit is available in abundance in the system, the Federal body may start absorbing some of the bonds it issued that shall result in the decrease in the liquidity in the system.
This measure is used to maintain inflationary levels in the Economy.
Central Banks all around the world use the money market and monetary policies to control currency, liquidity, inflation and growth depending upon the pressing priority of that economy. Currently, India is supposed to be in the cycle of rate cuts as the inflation has cooled down and more liquidity will help easy credit in the market. Easy credit helps in ease of doing Business.