What is the federal funds rate?

The federal funds rate refers specifically to the interest rate at which banks lend reserves to one another on an overnight basis. This interbank lending occurs primarily for banks to meet reserve requirements or manage liquidity. When a bank has excess reserves, it can lend them to another bank that needs additional reserves, and the rate charged for this transaction is known as the federal funds rate.

This mechanism is crucial for ensuring that the banking system remains liquid and stable, allowing banks to manage their cash flow effectively. The federal funds rate is an important tool in monetary policy and serves as a benchmark for other interest rates within the economy, influencing everything from loan rates to savings interest.

Other options refer to different banking relationships and charges but do not pertain to the specific nature or definition of the federal funds rate. For instance, while the Fed does charge banks for direct loans, that charge is different from the interbank lending rate, and the other options involve entities like the U.S. Treasury or FDIC, which operate under different frameworks and do not define the federal funds rate.