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Federal funds rate

The Federal funds rate is the interest rate at which banks loan each other overnight funds from their balances with the Federal Reserve.

Expanded Definition

The Federal funds rate is a target rate set by the Federal Reserve for overnight loans between banks. These overnight loans enable banks to maintain enough reserves to meet federal requirements.

The target interest rate doesn't determine how much it costs to borrow funds overnight; the actual rates are set by the open market. The weighted average of all of these transactions determines the effective rate, which is usually slightly higher than the nominal or target rate.

Because of this relationship between the target and the effective rates, changing the Federal funds rate either encourages or discourages banks from raising capital through borrowing. In this way, the Federal Reserve affects how freely the economy operates.

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