Federal Funds Market
Every night, the moon comes out, the sun goes to bed, and banks are making overnight loans to each other.
Banks have to meet certain "reserve requirements," meaning they have to have a certain amount of funds on hand each night. One night, a bank might have more money than they need on hand, so they offload the extra onto another bank in the form of a loan. Another night, that same bank might come up short, so it takes a loan from another bank to meet those reserve requirements. Banks can also borrow directly from the Federal Reserve, but they usually borrow from each other before doing that.
The federal funds market is the total of all of these transactions, or all of the money borrowed by all of the banks. The federal funds market is full of "federal funds," because those loans are subject to interest rate targets set by the Federal Reserve Open Market Committee. When they set the interest rates high, borrowing will go down. When they set the interest rates low, borrowing will go up. Well, that’s the idea anyway.
See: FOMC.
Related or Semi-related Video
Finance: What is the Federal Funds Rate?21 Views
Finance a la shmoop what is the federal funds rate? all right think about it like
a suggested tip amount at a restaurant or on uber or lyft and you're going to [Man stood outside Pete's Pizza store]
gauge how your waiter or driver will react to that number
warmly coldly or well that's basically what the federal funds rates intentions
are as it relates to heating up or cooling down the economy well the Fed
heats and cools via the manner in which it rents money to its henchmen, the US
banking system that is in the most basic vanilla transaction the Fed rents money [Briefcase of cash lands outside Federal State building]
to banks for 1% a year and those banks then turn around and market that
money in the form of loans for homes and cars and re rents
that money with a big fat markup at three four five six seven eight percent
or more well a fair number of deadbeats exist on the planet they don't pay back [people appear all across a map of earth]
the money they promised to pay back and while sometimes the bank has to eat the
dough they loaned or at least incur a lot of lawyer bills chasing down the [Lawyer chasing man in a car]
deadbeats and in the event of a calamitous economic situation well,
banks need to be rock-solid so they can't lend out every dollar they have
that is they have to keep a fair amount of equity on their books so that if bad
things really do happen then they have what are called reserves well the bank [Bank reserve vault of cash appears]
also keeps reserves for direct daily deposits so that someday when a bunch of
people come in for their cash the bank can't turn their pockets inside out and [Person turns pocket inside out]
say yeah sorry we gave it all to the nice man wanting to buy a sports car
well that kind of thing leads to panic and disaster and it has sadly in our
country's history when a third of the banks went bankrupt in the Great
Depression so what happens when a bank has less money than it legally needs to
have as a reserve? well it borrows money in a short-term overnight loan from
either the Federal Reserve Bank or from other banks that keep their own reserves [Money transfers from Federal Reserve to bank]
at the Federal Reserve sort of like borrowing from Peter to pay Paul keeping
all that reserve grid number uh steady all right well now
we all know that borrowing money is not free
if a bank borrows overnight from other banks it is charged an interest rate at
the current federal funds rate the Federal Reserve influences that rate
while banks just need to be careful about paying back those loans because
stiffing the Fed is significantly more dangerous to your life than
sniffing your waiter at Applebee's [Object hits man outside Applebee's]
Up Next
The Federal Open Market Committee's purpose is to manage financial outcomes through monetary policy.
What is the Federal Budget? The Federal budget is the US government’s list of spending allocations for a designated year. It includes domestic an...