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Finance: What is the Federal Funds Rate? 22 Views


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What is the Federal Funds Rate? The federal funds rate is the interest rate used for overnight lending between banks. The amount banks are able to lend out depends on their reserve balances (as determined by the Fed). Anything above and beyond what they need on hand to service clients can be used in bank to bank lending that happens at the federal funds rate.

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Transcript

00:00

Finance a la shmoop what is the federal funds rate? all right think about it like

00:07

a suggested tip amount at a restaurant or on uber or lyft and you're going to [Man stood outside Pete's Pizza store]

00:12

gauge how your waiter or driver will react to that number

00:17

warmly coldly or well that's basically what the federal funds rates intentions

00:23

are as it relates to heating up or cooling down the economy well the Fed

00:28

heats and cools via the manner in which it rents money to its henchmen, the US

00:33

banking system that is in the most basic vanilla transaction the Fed rents money [Briefcase of cash lands outside Federal State building]

00:38

to banks for 1% a year and those banks then turn around and market that

00:43

money in the form of loans for homes and cars and re rents

00:49

that money with a big fat markup at three four five six seven eight percent

00:53

or more well a fair number of deadbeats exist on the planet they don't pay back [people appear all across a map of earth]

00:58

the money they promised to pay back and while sometimes the bank has to eat the

01:02

dough they loaned or at least incur a lot of lawyer bills chasing down the [Lawyer chasing man in a car]

01:06

deadbeats and in the event of a calamitous economic situation well,

01:10

banks need to be rock-solid so they can't lend out every dollar they have

01:15

that is they have to keep a fair amount of equity on their books so that if bad

01:20

things really do happen then they have what are called reserves well the bank [Bank reserve vault of cash appears]

01:25

also keeps reserves for direct daily deposits so that someday when a bunch of

01:30

people come in for their cash the bank can't turn their pockets inside out and [Person turns pocket inside out]

01:35

say yeah sorry we gave it all to the nice man wanting to buy a sports car

01:40

well that kind of thing leads to panic and disaster and it has sadly in our

01:45

country's history when a third of the banks went bankrupt in the Great

01:48

Depression so what happens when a bank has less money than it legally needs to

01:53

have as a reserve? well it borrows money in a short-term overnight loan from

01:59

either the Federal Reserve Bank or from other banks that keep their own reserves [Money transfers from Federal Reserve to bank]

02:02

at the Federal Reserve sort of like borrowing from Peter to pay Paul keeping

02:06

all that reserve grid number uh steady all right well now

02:10

we all know that borrowing money is not free

02:12

if a bank borrows overnight from other banks it is charged an interest rate at

02:17

the current federal funds rate the Federal Reserve influences that rate

02:22

while banks just need to be careful about paying back those loans because

02:26

stiffing the Fed is significantly more dangerous to your life than

02:30

sniffing your waiter at Applebee's [Object hits man outside Applebee's]

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