\::: Cura de Ars :::/// » fed funds prime http://www.curadears.org Tue, 07 Sep 2010 12:42:08 +0000 http://wordpress.org/?v=2.9.2 en hourly 1 The Fed funds rate, how it works and how its related to other rates in the economy? http://www.curadears.org/fed-funds-prime/the-fed-funds-rate-how-it-works-and-how-its-related-to-other-rates-in-the-economy http://www.curadears.org/fed-funds-prime/the-fed-funds-rate-how-it-works-and-how-its-related-to-other-rates-in-the-economy#comments Wed, 06 Jan 2010 05:39:17 +0000 admin http://www.curadears.org/fed-funds-prime/the-fed-funds-rate-how-it-works-and-how-its-related-to-other-rates-in-the-economy In recent years the Fed’s monetary target has been the Fed funds rate. How does the Fed raise or lower that rate and how is that rate related to other rates in the economy such as the prime rate? The Fed mainly uses open market operations to raise or lower the Fed Funds Rate. If [...]


]]> In recent years the Fed’s monetary target has been the Fed funds rate. How does the Fed raise or lower that rate and how is that rate related to other rates in the economy such as the prime rate?

The Fed mainly uses open market operations to raise or lower the Fed Funds Rate. If they need to lower the rate, they will buy federal securities (treasury bonds) in the market. This means they credit the buyer with money in exchange for the securities, which means the buyer now has more money on its hands. More money means banks are willing to lend at lower interests rates.

Beside open market operations, the Fed could also adjust the reserve rate for banks, which is the percentage of deposits that banks are required to keep on hand instead of lending. If you lower the requirement, banks are able to lend more, which again lowers interest rates.

One other thing they can do is change the discount rate. This is the interest rate the Federal reserve banks will charge other banks if they need a quick loan in order to meet their reserve requirements. If this rate is low, banks will be a little more willing to lend when they are close to having just enough reserves on hand because they can get a quick loan for not too much. If the rate is high, banks will be cautious and keep extra reserves to make sure they don’t go below the discount rate. So again, the point is how much money is being lent.

The Fed funds rate is the interest rate that banks charge each other for overnight loans. This is usually a very low risk loan for a bank to make. Other rates like prime rate, are higher because they are riskier loan types. The prime rate is what banks will charge their best and most creditworthy customers. Since banks can get money that they need at the Fed funds rate, they are willing to lend to these types of customer for an amount that is the Fed funds rate plus an amount that accounts for the additional risk of these customers, plus some profit.

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