2

As I understand it, the Fed will set a target for what it wants the Federal Funds Rate to be and then try to achieve this goal through its open market operations. Is the amount of volume that the Fed trades significant enough to increase or decrease the money supply, forcing banks to lend at the Fed fund rate or are there other factors that motivate the banks to lend at this rate?

  • 1
    Not sure if your question is answered in the Wikipedia article on Federal Funds Rate given the other FOMC mechanism like adjustments in the interest rate on reserves. Perhaps you can edit and quote from the wiki article to expand upon what you are looking for. – Morrison Chang Sep 18 '18 at 5:21
  • What I want to know is for what reasons do banks raise or lower the rate for overnight lending when the fed announces an increase or decrease in the fed fund rate – user5246445 Sep 18 '18 at 14:46
  • 1
    See the answers on this question: Why are bank rates based on the federal interest rate? – Morrison Chang Sep 18 '18 at 15:16
1

In simple terms...

When the Fed sets its Fed Funds Rate, it isn't directly moving the rates up or down. They are setting an overnight rate that they will pay Banks for depositing money with them.

So if the Fed raised the rate from 1% to 2%, more Banks would be willing to deposit their money with them, and would have less of an incentive to lend the money out to consumers/borrowers/people.... unless they raise their rates.

For example: Why would a Bank decide to lend out money for 3%? Why take the risk when they could simply deposit their money with the Fed for 2%? The only way they see an incentive to lend money out is if they can make a larger return for their risk... therefore they'll push their loan rates to 4%. This starts a domino effect where rates rise across the board.

0

As far as I understand, when the FED announces a new target rate, banks are certain that it (the FOMC) will carry out the necessary operations to enforce that target rate. Since banks know this, they no longer wait for the FED to actually make the move, and simply act upon the announcement.

Your Answer

By clicking "Post Your Answer", you acknowledge that you have read our updated terms of service, privacy policy and cookie policy, and that your continued use of the website is subject to these policies.

Not the answer you're looking for? Browse other questions tagged or ask your own question.