When banks and institutions have excess reserves (fractional-reserve-banking-is-how-money-is-printed), they can deposit at regional federal reserve banks.
When other participants have insufficient cash on hand for lending and reserve needs, these funds can be lent to them. Unsecured and at low interest rates (the “overnight rate” - the period for which the loans are made.)
Federal Funds Rate
The Federal Reserve Bank sets a range for the fed funds rate that banks loan to each other on an overnight basis. It affects inflation, growth and employment.
This rate also influences the interest rates that banks charge borrowers, which has additional impacts on inflation and economic conditions:
- Lower interest rates -> economy grows, inflation increases (because people can borrow more and spend more and how-inflation-prices-and-interest-rates-connect)
- Higher interest rates -> economy slows, inflation decreases (because people save more since yield is better)