Understanding federal funds rate means understanding the Federal Open Market Committee (FOMC). The Federal Open Market Committee sets the target interest rate. This refers to the term federal funds rate. It targets the rating from commercial banks that borrow or lend their excess reserves overnight. To be exact, FOMC is the policy maker of the Federal Reserve System. They meet around eight times a year to get the target on federal funds rate. This activity becomes a part of monetary policy. The goal of monetary policy is to support economic growth.
In detail, the federal funds rate is the interest rate the banks charge other institutions. They charged this in order to lend excess cash to them from their reserve balance on an overnight basis, said Investopedia. In the policy, the banks must get a reserve equal to a certain percentage of their deposits. This is in an account at the Federal Reserve bank. The bank must keep the amount of money in its Fed account. The term for this is reserve requirement. Reserve requirement refers to a percentage of the bank’s total deposits.
Financial institutions must maintain interest-bearing accounts at the Federal Reserve banks. This is to make sure that the banks own enough money to cover withdrawals from depositors. Plus, they must have enough money for other obligations. Money in their reserve exceeding the required level is available for lending to other banks. This might influence a shortfall. Finally valances in the bank’s account meet reserve maintenance periods. This reserve maintenance period functions as determining whether it meets the reserve requirement.