Letson
Federal funds consist of excess reserves plus surplus from bill settlement. Due to frequent changes in the balance of deposits, the reserves of member banks may be surplus or insufficient. If the reserve is insufficient, the bank can borrow from the federal fund to make up the reserve amount, or use it to clear the difference in bill exchange. The way is to transfer interest to each other through the Fed account, and remit the interest within the agreed time or settle the interest with the principal at any time. Sometimes, federal funds can also refer to funds used by the Federal Reserve to pay for the purchase of US government securities.
Letson
The interest rate of lending federal funds between member banks is called the federal funds rate, which changes every day and is a sensitive indicator of interest rate trends in the United States. This interest rate is one of the two benchmark interest rates controlled by the Federal Reserve, and the other benchmark interest rate is the rediscount rate.
Letson
The federal funds rate is relatively low, usually lower than the official discount rate. This low interest rate and high efficiency (daily funds, unsecured) make the transaction volume of federal funds quite large, and the federal funds rate has become the most important short-term interest rate in the US financial market. The daily interest rate of the federal funds is representative and is an important parameter of the official discount rate and preferential interest rate of commercial banks.
Letson
In fact, the Fed cannot directly determine the federal funds rate, but it can effectively control the federal funds rate by buying and selling bank bonds. This process is usually very rapid.