Federal Funds Rate
| interest rate | height |
|---|---|
| European Central Bank (valid from: September 18, 2019) | |
| Deposit rate (deposit facility) | −0.50% |
| Base rate (main refinancing operations) | 0.00% |
| Marginal lending rate (marginal lending facility) | 0.25% |
| Swiss National Bank (valid from: June 13, 2019) | |
| SNB policy rate | −0.75% |
| Federal Reserve System (effective March 16, 2020) | |
| Federal funds rate target range | 0.0 to 0.25% |
| Primary Credit Rate | 0.25% |
| Bank of Japan (effective December 19, 2008) | |
| Discount rate (basic discount / loan rate) | 0.30% |
| Bank of England (effective March 19, 2020) | |
| Official Bank Rate | 0.1% |
| Chinese People's Bank (valid from: February 20, 2020) | |
| Discount rate (one-year lending rate) | 4.05% |
The Federal Funds Rate (often abbreviated as the Fed Rate ) is the rate at which American financial institutions (including banks and savings banks ) lend money to one another in order to balance their balances within the framework of reserve requirements at the central bank . Since this happens on a daily basis, one also speaks of overnight credit ( German literally: overnight credit ). The effective (actual) interest rate can deviate from the nominal , which is why open market transactions are mainly used to control and maintain the nominal interest rate formulated as a monetary policy objective .
When the media talk about the Federal Reserve (Fed) changing its key interest rate , it usually refers to the Federal Funds Rate.
method
Reserve holdings
US banks are required by law to hold certain proportions of reserves. Optionally, these can be held with the Fed as non-interest-bearing cash reserves or cash on hand. The share of reserves is determined by the Fed on the basis of the inventory of assets and liabilities of each credit institution. 10% of the total value of sight deposits is usual .
When a US credit institution makes a loan in the normal course of business , it reduces its money and therefore its reserve. If this proportion of the reserve falls below the required reserve ratio, the bank must increase its reserves in accordance with the requirements of the Fed. The bank can borrow the necessary capital from another bank which has a reserve surplus with the Fed. The interest rate that the lending bank pays the lending bank is negotiated in the interbank business . This weighted average of this interest rate for all interbank transactions is known as the effective federal funds rate.
When the Fed refers to a “changing interest rate,” it is almost always referring to the nominal interest rate, which is set as the target by the governors of the central bank. Through open market operations , the Fed controls the market so that the actual federal funds rate is then as close to this target.
Another way banks can borrow capital to maintain their required reserve requirements is by taking out a loan from the Fed. This loan is controlled by the Fed. This discount rate is usually higher than the federal funds rate. The differences between these two types of loans often lead to confusion between the federal funds rate and the discount rate. Another difference is that the Fed cannot set an exact overnight rate, but can set a specific discount rate.
Controlling the Federal Funds Rate
The Federal Funds Rate target is set by the Federal Open Market Committee (FOMC). Depending on the agenda and the state of the economy in the United States, FOMC members raise or lower the rate or leave it unchanged. It is possible to make a prediction about market expectations of the FOMC decision. This happens at the meetings of the Chicago Board of Trade (Chicago Chamber of Commerce, CBOT). The financial media are reporting on the probabilities of Fed Funds futures contracts .
Applications
Interbank transactions (money lending among banks) are an easy way for credit institutions to raise capital quickly. For example: a bank wants to give an industrial company a major loan, but does not have the time to wait for deposits or loan payments. Then she can borrow this amount from other banks quickly and easily.
Effect of Changes in Federal Funds Rate
If the federal funds rate rises, banks are advised not to take out interbank loans, as it is then "more expensive" to obtain this money. On the other hand, if the interest rate falls, banks will be encouraged to borrow money. The money that has become "cheaper" is intended to stimulate investment and consumption in order to support the economy. However, a rate cut can also drive prices up and thus inflation . Despite the short-term availability options, monetary policy tends to have a medium to long-term effect on the national economy . Not to be underestimated, however, is the psychological signaling effect on market participants who are already short-term investment and Influence consumption decisions.
This rate acts as a regulatory tool to steer the free US economy. The consequence of this is that there is a certain interdependence with the world economy .
By setting a higher discount rate, the Fed discourages banks from borrowing from the Fed. However, as a last resort, she reserves the right to spend money.
example
The following example explains the relationship between the federal funds rate and its impact on the economy.
If the interest rate rises, business revenue will decrease due to a decline in consumer behavior . This effect is not immediately noticeable. Rather, it is a gradual process that only reaches its maximum extent after approx. 1 to 1.5 years. It can be deduced from this that the companies have to reduce their production due to the loss of sales. This reduction in production happens more slowly, so that it only becomes noticeable after about 2 years. The decline in production also reduces employment , which is reflected in an increase in the unemployment rate .
The following example shows that monetary policy has an effect on economic agents. But you can also see that this is a short to medium-term process.
Comparison with the LIBOR
Although the London Interbank Offered Rate (LIBOR) and the Federal Funds Rate have the same function, i.e. regulate the interest on interbank loans, they are different in a few ways:
- The (target) federal funds rate is a key interest rate that is set by the FOMC and regulates US monetary policy.
- The effective federal funds rate is calculated from the usual interest rates of credit institutions that are under the supervision of the American authorities.
- LIBOR is calculated from the usual London bank interest rates. The main difference there is not the same minimum reserve requirement .
- Federal Funds Rate is achieved by doing business on the Domestic Trade Desk of the Federal Reserve Bank of New York , which trades primarily in domestic securities (government and federal securities).
- LIBOR can, but does not have to be, used to derive terms and conditions. It is not fixed in advance, but that does not mean that it has no macroeconomic background.
Predictions by the market
A change in the federal funds rate affects the value of the dollar and the amount of loans issued. This in turn has an impact on new economic activities (e.g. business investments). The prices of options contracts called "fed funds futures" (traded on the Chicago Board of Trade) can be used to infer market expectations of future Fed policy changes. Such implied probabilities are published by the Cleveland Fed.
Current changes and historical interest rates
- On January 22nd, 2008 the Fed cut the key interest rate by 75 basis points from 4.25% to 3.5%. The cut was enforced by a deteriorated economic outlook and increasing economic downside risk.
- On January 30, 2008, the Fed cut the key interest rate by 50 basis points from 3.5% to 3.0%. The FOMC wants to promote moderate growth and mitigate the economic downside risks. "
- On March 18, 2008, the Fed cut the key interest rate by 75 basis points from 3.0% to 2.25%. The aim is to provide the US economy, unsettled by the mortgage crisis, with cheaper money and to counteract the looming recession .
- On April 30, 2008, the Fed cut the key interest rate again by 25 basis points from 2.25% to 2.0%. Two members of the Fed's Open Market Committee voted against this decision.
- On October 8, 2008, as part of a concerted action by central banks around the world, the Fed cut the US key interest rate by 50 basis points from 2.0% to 1.5%.
- On October 29, 2008, the Fed cut the federal funds rate by another 50 basis points from 1.5% to 1.0%.
- On December 16, 2008 it was announced that the target range of the Federal Funds Rate would be set at 0.0 to 0.25%.
- This target range was not changed again until seven years later. On December 16, 2015 it was increased to 0.25-0.5%.
- The target range was further increased on December 14, 2016 to 0.5 to 0.75%.
- On March 16, 2020, the Fed cut the key rate from 1.75% to 0.25%.
Historical interest rate trend of the effective federal funds rate since 1954
Important key interest rates of the ECB and Fed since the ECB was founded
Federal Funds Rate and US Manufacturing Capacity Utilization
Federal funds rate and key interest rates of the Deutsche Bundesbank and the European Central Bank
Individual evidence
- ↑ Fed funds rate ; Bankrate.com - Retrieved April 16, 2008.
- ↑ Blanchard, Olivier; Illing, Gerhard (2006) “Macroeconomics”, 4th updated and expanded edition, Munich: Pearson Studium, pp. 162f
- ↑ www.federalreserve.gov - Open Market Operations in the 1990s (accessed: April 16, 2008, 11:12 pm CET; PDF; 102 kB)
- ↑ British Bankers' Association - Libor ( Memento of the original from December 22, 2007 in the Internet Archive ) Info: The archive link was automatically inserted and not yet checked. Please check the original and archive link according to the instructions and then remove this notice. (Accessed: April 16, 2008, 11:12 pm CET)
- ↑ a b c d Historical Changes of the Target Federal Funds and Discount Rates. newyorkfed.org, accessed May 9, 2016 .
- ↑ www.SüdOstSchweiz.ch - Text archive: Federal Funds Rate ( page no longer available , search in web archives ) Info: The link was automatically marked as defective. Please check the link according to the instructions and then remove this notice. (Accessed: April 25, 2008, 00:02 CET)
- ↑ October 2008 Börse.ard.de October 8, 2008 ( page no longer available , search in web archives ) Info: The link was automatically marked as defective. Please check the link according to the instructions and then remove this notice.
- ↑ Börse.ard.de, October 29, 2008 ( page no longer available , search in web archives ) Info: The link was automatically marked as defective. Please check the link according to the instructions and then remove this notice.
- ↑ press release. federalreserve.gov, December 16, 2008, accessed May 9, 2016 .
- ↑ press release. federalreserve.gov, December 16, 2015, accessed May 9, 2016 .
- ↑ press release. federalreserve.gov, December 14, 2016, accessed February 12, 2017 .
- ^ Federal Reserve Actions to Support the Flow of Credit to Households and Businesses. Federal Reserve, accessed March 16, 2020 .
Bibliography
- Blanchard, Olivier; Illing, Gerhard (2006): Macroeconomics . 4th updated edition. Munich: Pearson Studies, ISBN 978-3-8273-7209-3