Tuesday, May 12, 2009

Federal Funds

Suppose it is 222:50 p.m. and a bank needs $10 million by 3:00 p.m. to meet the reserve requirements set by the Federal Reserve. Obviously it is too late to attract additional deposits,and the bank must find a quick way to acquire the funds. One way the bank can obtain such funds on short notice is to acquire federal funds. Federal funds are simply short-term (usually overnight)loans between banks. The funds are loaned at an interest rate known as the federal funds rate. They are called federal funds because they are held in deposit at the Federal Reserve rather than because they are loaned by the federal government. In fact,the transfer of federal funds is merely a bookkeeping transfer from the ledger of a bank with an excess of reserves to the ledger of a bank with deficient reserves.

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