The Federal Funds Rate Explainer
The federal funds rate is the rate on overnight unsecured borrowing and lending of reserve balances among eligible institutions. The Federal Open Market Committee sets a target range, while the effective federal funds rate is calculated from actual transactions reported in the market.
The Federal Reserve does not command each transaction to occur at one number. It encourages market rates to stay within the target range using administered tools, especially interest paid on reserve balances and the overnight reverse repurchase facility. Market conditions determine the exact effective rate.
Changes in the target range influence other short-term rates, financial conditions, asset prices, and borrowing costs. Banks may adjust prime rates, deposit rates, and loan pricing, but the pass-through varies with competition, credit risk, maturity, funding sources, and expectations about future policy.
The federal funds rate is not a consumer loan rate, mortgage rate, or Treasury yield. Those rates incorporate additional risks and time horizons. A policy change works through many channels and with lags, so a quarter-point FOMC move does not imply every household or business rate changes by exactly the same amount.
Eligible institutions trade reserve balances overnight.
The effective rate comes from reported transactions.
Interest on reserves and overnight reverse repos help guide short-term rates.
The exact market rate is not mechanically fixed.
Credit, maturity, competition, and expectations affect pass-through.
Consumer rates need not move one-for-one.
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