What is the Federal Funds Rate?

The Federal Funds Rate refers specifically to the interest rate at which banks lend reserves to one another overnight. This is a critical component of the banking system and monetary policy. When banks have excess reserves beyond what is required, they will often lend that surplus to other banks that may be in need of meeting reserve requirements. The rate charged in these transactions is the Federal Funds Rate, and it is influenced by the monetary policy decisions made by the Federal Reserve.

This rate is pivotal because it affects overall economic activity. Changes in the Federal Funds Rate can influence borrowing costs for consumers and businesses, impacting economic growth. A lower Federal Funds Rate typically encourages more lending and investment, while a higher rate can cool off inflation by making borrowing more expensive.

Other options, while they pertain to banking and economics, do not define the Federal Funds Rate accurately. The interest rate charged to customers for loans relates to consumer banking rather than interbank lending. The rate of inflation pertains to the general increase in prices within the economy and not specifically to interbank lending rates. Lastly, the percentage of deposits that banks are required to hold refers to the reserve requirement, which is a separate regulatory measure that ensures banks maintain a certain level of reserves.