Question

What is the Federal funds rate and how does the Fed use it as an operating target? How does the Fed influence the Federal Funds rate? describe in a short paragraph

Answer 1

Federal funds rate is the rate at which commercial banks lend overnight loans to each other. Fed can use this rate as a target to achieve its long term goal of inflation and employment. Fed can increase this rate when inflation rate is too high or there is an inflationary gap.

When this rate is increased (and remains below the discount rate), banks are less willing to lend to each other which suggests that lending is decreased. These results in fewer loans being made and so the market liquidity is reduced. As a result, money supply is reduced and rate of inflation is brought back to a level that hovers around its target.