federal funds rate
The interest rate at which banks lend money to each other overnight, set by the Federal Reserve as its primary tool for controlling inflation and stimulating the economy.
Example
“When the Fed raised the federal funds rate from 0% to 5.25%, mortgage rates and credit card APRs quickly rose.”
Memory Tip
Federal funds rate = the Fed's main lever. Raise it to fight inflation, cut it to stimulate growth.
Why It Matters
The federal funds rate affects how much interest you pay on credit cards, mortgages, and savings accounts. When the Federal Reserve raises this rate, banks pass those costs along to consumers through higher borrowing rates, which makes it more expensive to borrow money for big purchases like homes or cars.
Common Misconception
Many people think the Federal Reserve directly sets the interest rate they receive on their savings account or pay on their mortgage. In reality, the federal funds rate is an overnight lending rate between banks, and commercial banks only indirectly adjust consumer rates based on what the Federal Reserve targets.
In Practice
If the Federal Reserve raises the federal funds rate to 5 percent, banks might increase their prime lending rate to around 8.5 percent within weeks. This means a homebuyer seeking a mortgage might see rates jump from 6.5 percent to 7 percent, adding hundreds of dollars to their monthly payment on a $400,000 home loan.
Etymology
FEDERAL (national) FUNDS (bank reserve money) RATE (interest percentage). The rate banks pay to borrow from each other.
Common Misspellings
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