Federal Funds Rate
Plain definition
The interest rate at which banks lend reserve balances to each other overnight; the Federal Reserve's primary monetary policy target.
In economics
The Fed sets a target range for the federal funds rate, then uses open market operations and interest on reserves to keep the actual rate inside it. Changes ripple through the economy: mortgages, auto loans, and business credit all move with it. The Taylor rule offers a benchmark for where the rate 'should' be, based on inflation and the output gap.
Example
The Fed raises the federal funds target range from 4.25-4.50% to 4.50-4.75%. Within days, banks raise prime lending rates, variable-rate mortgages reset higher, and corporate borrowing costs rise, cooling spending across the economy.
The federal funds rate is confused with the discount rate and with the interest rate consumers pay. The funds rate is the interbank overnight rate (the policy target); the discount rate is the Fed's direct lending rate to banks; consumer loan rates are higher because they add risk and profit margins on top.