What does the federal interest rate mean?

The federal interest rate is referred to the interest rate of federal funds. The federal fund rate is mainly under the influence of the Federal Reserve which is the coordinator of the monetary policy in the United States. By selling and buying treasuries, the Federal Reserve influences the US rates for federal funds and also controls the money supply. The Federal Reserve interest rates today are a mirror for the situation of the American economy.

Federal funds

The American legislation imposes on all banking institutions in the United States to hold funds called federal reserves at the Federal Reserve. However, there are uncontrollable circumstances which do not allow certain banks to meet this mandatory requirement. In this situation, banks lend money to other banks against an overnight interest. The funds which they take to deposit at the Federal Reserve are called federal funds. This interest rate is called federal fund rate. Any inflation news may have a major impact on the fed rates.

How it works

The federal interest rate is negotiated between the two banks involved in the transaction. However, its trend is set by the Federal Reserve which controls all interest rates by increasing or decreasing money supply. Trading treasuries to control money supply is called open market operation. The PMR and the PLR The prime mortgage rate and the prime lending rate are both subject to the changes occurring in the values of the federal rate. Open market operation The open market operation is the only tool which the Federal Reserve can use to implement the monetary policy in the States. These operations are controlled by the Federal Open Market Committee (FOMC) which sets short and long-term goals. The short-term goals refer to reserves and the price of the reserves (the federal interest rate). The long-term goal is to maintain a balance between monetary supply and interest rate to ensure price stability and economical growth.

Federal discount rate

Discount window The federal discount rate is the interest rate which any commercial bank has to pay to the Federal Reserve Banks for credit through the loan facility called discount window. Primary credit The first type of discount rate is the prime interest rate paid by a bank which is granted short-term credit called primary credit. Extended primary credit The second type of discount rate is the rate due by a bank for a secondary credit which is an extended primary credit. This rate is above the prime interest rate. Rate for the seasonal credit The third type of discount rate is the rate for the seasonal credit which is a longer term credit for specific seasonal activity. This is an average of the first two discount rates.