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Definition: Fed Funds Rate
Fed Funds rate is the rate at which one bank in the US lend money to another bank to meet its overnight Federal Reserve requirements. Fed Funds rate is the most important rate in the US economy because it directly and indirectly affects the functioning of the economy. All the banks in the US holds Federal Reserve requirements on the daily basis. Whenever banks go short of money on any particular day, banks charge Fed Funds rate to each other to transfer money from one bank to another bank.
Fed Fund Rate is regulated by Federal Reserve. When it wants to lower Fed Funds rate, it buys securities from the member banks giving more money to the banks. So this will lead to decrease in Funds rate because banks will have enough federal cash reserve. On the other hand when Federal Reserve wants to increase Fed Funds Rate, it sells securities to the banks which will reduce cash in the federal reserve of the banks which will drive in the increase of the Fed Funds Rate. Federal Reserve uses Federal Open Market Committee to control Fed Funds Rate.
Fed Funds rate also helps control the economy of the US. It controls inflation by maintaining healthy economic growth. To raise or reduce the Fed Funds rate is part of the monetary policy of Federal Reserve. It keeps an eye on economic indicators to check whether economy is speeding up or slowing down. As per the state of the economy, Fed Fund rates are adjusted.