It is to note that FOMC cannot force the bank to charge the exact federal funds rate. On the other hand, the FOMC could set a target rate for the guidepost. The actual interest rate of a lending bank depends on the negotiations between two involving banks. This is famous for the effective federal funds rate. It has the type of the weighted average of interest rates for all transactions. In other words, the FOMC cannot mandate several federal funds rates. Thus, the Federal Reserve System could adjust the money supply. The purpose is for the interest rates to move towards the target rate.
When the amount of money in the system increases, the interest rates could fall. On the other hand, if the money supply decreases, the interest rates could rise. The Federal Reserve rate does not only decide the rate but also sets a discount rate. This is actually the interest rate that the Fed would charge for the banks from direct borrowing. Sometimes, the rate tends to be higher than the target fed funds rate. The purpose is to help banks to borrow from other banks lower than the federal funds rate. In the U.S. interest rates are very crucial, this is to say that the federal funds rate is vital. It is largely because the rate affects both monetary and financial conditions. It has critical aspects of a major economy in general like growth, inflation, as well as employment.
In addition, the federal funds rate could influence short-term interest rates. Although it gives indirect impact. It could influence many like home and auto loans to credit cards. This is because lenders tend to set their rates by referring to the prime lending rate.
