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Federal Funds rate, Its Impact, and How It Works

WHAT IS FEDERAL FUNDS RATE?

In the United States, Federal Funds Rate is the rate of interest at which banks charge each other to lend Federal Reserve’s fund overnight. Fed funds rate is also a standard for interest rates of debt, bank loans and credit cards etc. It varies from time to time, and it can also correlate to the United Nations economy very well. Therefore, Fed funds rate is very important from the point of view of the national economy as well as the global economy.

Prime rates are one of the most affected interest rates due to the fed funds rate. Prime rates are the interest rates of a bank for their most creditworthy consumers.

The Federal Open Market Committee (FMOC) is the board which is responsible and determines the fed funds rate. Federal Open Market Committee (FOMC) contains total 12 members, 7 governors and 5 presidents of the federal banks. Federal Open Market Committee’s meeting decides the fed funds rate. 8 meeting held’s throughout the whole year of FOMC, every seventh week. Interest rate between the lending and borrowing bank to borrow the funds is negotiated between the two banks, the average of this rate is near about the effective fed funds rate.

Federal Funds rate, Its Impact, and How It Works
Federal Funds rate, Its Impact, and How It Works

IMPACTS OF FEDERAL FUNDS RATE

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There are so many changes take place in real world when the fed funds rate fluctuates. We will find when the Federal Open Market Committee changes the interest rate then how consumers have to pay more as per interest increases too and why business will face more costs joint to expanding their options.

DateIncreaseDecreaseLevel (%)
March 1601000-0.25
March 30501.00-1.25
2020, FOMC’s target federal funds rate or range Source: federalreserve

Following are the some important factors on which changes of federal funds rate impact:

CREDIT CARDS & LOANS

When the fed funds rate decreases by Federal Open Market Committee (FOMC), the interest of credit cards and loans also get reduced by the banks. Change in fed funds rate cause the business expands. When rates are low consumers of the bank use their there are cards for shopping etc. which effect the income of the banks.

PRIME RATES

Increasing in the fed funds rate instantly fills a boost in the jump in the prime rates which banks charge to their credit worthy consumers. Prime rates are the of a main cause of other consumer interest fluctuation as in the increasing in the fed funds rates as the prime rates increase means that banks will increase their interest rate for everything is fixed, and steady rate borrowing costs when evaluate risk or less credit worthy companies and consumers.

UNITED STATES NATIONAL DEBT

Due to the increase in the fed funds rate, there is an increase in national debt for the U.S. government too. Increase in the fed funds rate cause the increase the borrowing costs for United Nation Government. Centre for Economic and Policy Research of U.S.A in Washington, clears that due to increase in interest rates the United Nation Government ends up funding more than $2.3 trillion in the very next decade.

STOCK MARKET

One of the most important effects of change in fed funds rate can be clearly see in the stock market. Whenever the meeting held of Federal Open Market Committee, one of the most interested categories is of stock market investors. There is an interesting thing to know about the relationship between stock market and fed funds rate, because they do not move parallel, they move inversely- as the fed funds rate cuts down, the stock market raises up and when the fed funds rate raise up it causes the stock market down. No one can ensure how the stock market will react to any decision in the fed funds rate.

HOW IT WORKS?

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Money is not just important; it is the most important thing to do any work. Money just work like oxygen foe business. Every bank needs money to start the business day. If a bank does not have money to start their business day they borrow from another bank, here’s the work of federal funds rate comes in.

The fluctuation of federal funds rate totally depends on Federal Open Market Committee (FOMC):

Lower Fed Funds Rate: Federal Open Market controls the Fed funds rate, if the FOMC wants to decrease the rates, the Fed purchases government securities from its member banks and hold it on to decease the Fed Funds Rate. They put pressure on banks to low rates so banks can lend out extra funds to each other. This is the process used by FOMC to lowers the fed funds rate.

Higher Fed Funds Rate: When Federal Open Market Committee wants to increase the interest rates they just do opposite. FOMC just sells government securities to the bank. This is how the Federal Open Market Committee (FOMC) works to increase and decrease the fed funds rate.

SACHIN AHIRWARhttps://personal-finance.in/
Hey, I’m Sachin. I’m a Blogger living in India. Guide for Personal Finance Planning & financial planning, Tax, Investment, Managing Money, Insurance, Retirement, Real Estate and Loans & more.

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