Federal Reserve System and Fed Rate

Fed Rate and Federal Reserve System have been in news for more than a year. Let us examine what is meant by the terms. 

In modern era, Financial Institutions and Banks have emerged as major institutions that have direct bearing on the progress of a country and wellbeing of the citizens. Knowing the importance of financial system, each country has formulated regulations and regulators to ensure prompt conduct of financial sector. Central Bank or regulator of the banking system in the United States is Federal Reserve System. In India, Reserve Bank of India (RBI) functions as the central bank. 

Federal Reserve System Fed Rate

Federal Reserve System

Federal Reserve system came into being on December 23, 1913 pursuant to the enactment of Federal Reserve Act. It is popularly known as the Fed or Federal Reserve. Major roles of the Fed or any such regulator include ensuring adequate supply of money in the market, containing inflation within acceptable levels, maintaining reasonable interest rates to ensure employment and maintaining value of currency in relation to the purchasing power of the currency of other countries (exchange rate). In short, it ensures financial stability through the policy termed ‘monetary policy’. 

Monetary policy means the actions taken by the regulator to discharge the functions entrusted to it diligently. Such policies impact the interest rates prevailing in the system which directly affect the economic activities of the country.  

Federal Funds Rate or Fed Rate

To ensure stability of banks, they are required to maintain stipulated percentage of their deposits or liabilities with Central bank. At the same time, banks come across situations of shortages or surpluses in their day to day affairs. In such a scenario, the bank that is short in funds borrow from the bank which is maintaining surplus reserve fund on overnight basis as unsecured loans, ie without any collateral security. The indicative interest rate at which such lending takes place in the United States is known as Federal Funds Rate or Fed Rate. The rate is fixed in the meeting of the Federal Open Market Committee. Such meetings normally occur eight times in a year. The committee can hold additional meetings too, if required in addition to the eight meetings that happens about seven weeks apart. The negotiated rate that a bank pays to borrow from another bank is known as Federal Funds Effective Rate.    

A lower Fed Rate encourages more borrowing and spending as the cost of borrowed fund is less. Fed rate was fixed at near zero (zero to 0.25%) since the recession in 2008, to boost the economy and nurture the collapsed housing market. However, in the meeting held on December 16, 2015, Fed Rate is raised to a range of 0.25% to 0.50%, thus bringing an end to an era of lower interest rates.   

John C S

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Federal Reserve System and Fed Rate
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Fed Rate and Federal Reserve System have been in news for more than a year. Let us examine what is meant by the terms. Federal Reserve system came into being on December 23, 1913 pursuant to the enactment of Federal Reserve Act. It is popularly known as the Fed or Federal Reserve.
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