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Federal Funds Market

Federal Funds Market. Sharon Ng January 2006. What is the Fed Funds Market?. Federal funds : the reserve balances that banks keep with the Federal Reserve Bank Fed Funds Market : market that is used by banks to borrow and lend these reserves Fed Funds Rate

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Federal Funds Market

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  1. Federal Funds Market Sharon Ng January 2006

  2. What is the Fed Funds Market? • Federal funds: the reserve balances that banks keep with the Federal Reserve Bank • Fed Funds Market: market that is used by banks to borrow and lend these reserves • Fed Funds Rate • Most common fed funds transaction: overnight, unsecured loan between two financial institutions

  3. Participants in the Fed Funds Market • Institutions that are required to hold Federal reserves • Commercial banks, savings and loan associations and credit unions • US government agencies and nonbank securities dealers • The Fed keeps track of the Federal Reserve deposits for all the banks

  4. Importance of the Fed Funds Market • Fed Funds Rate as a market setting rate • Important implications for money market participants • The Fed’s key tool for monetary and regulatory functions

  5. Fed Funds Transaction Mechanism Type 1: Bank-to-bank direct transactions • Telephone call to reach agreement • Fed transfers deposits • Usually for banks with established working relationships

  6. Fed Funds Transaction Mechanism Type 2: Through Broker Source: http://www.newyorkfed.org/education/addpub/monpol/chapter4.pdf

  7. Trading Volume? • No accurate measurement available • Average daily overnight Fed funds and repurchase agreements in December: $34.4 billion

  8. Relating to Monetary Policy • Federal Reserve Bank of New York executes Open Market Operations • Expansionary: purchase US Treasury Securities  bank reserves ↑  Fed Funds Rate ↓ Contractionary: sell US Treasury Securities  bank reserves ↓  Fed funds rate ↑ • Bring Effective Rate as close to Target Rate as possible

  9. Fed Funds Rate Volatility Target vs. Effective Fed Funds Rate January 2005 to January 2006 Source: Federal Reserve Bank of New York

  10. Fed Funds Rate Volatility • Lower reserve requirements and higher target funds rate will lead to greater deviations • Liquidity affects the effectiveness of OMO

  11. Conclusion • The important role of the Fed Funds Market of setting interest rates and carrying out monetary policy • For monetary policy to be effective, we need to ensure liquidity in the Fed Funds Market and minimize volatility

  12. Bibliography • “Federal Funds,” Federal Reserve Bank of New York, http://www.ny.frb.org/aboutthefed/fedpoint/fed15.html • “Federal Funds Market,” AmosWEB Encyclonomic WEBpedia, http://www.AmosWEB.com, (January 16, 2006) • Goodfriend, Marvin. Instruments of the Money Market, http://www.richmondfed.org, (January 16, 2006) • Hilton, Spence. Trends in Federal Funds Rate Volatility, Federal Reserve Bank of New York, July 2005 • “US Monetary Policy and Financial Markets,” Federal Reserve Bank of New York, http://www.newyorkfed.org/education/addpub/monpol/chapter4.pdf (January 16, 2006)

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