The topic of the Federal Funds Market straddles the sections I have titled You & Your Bank and the Federal Reserve System. Although the Federal Funds Market deals with the buying and selling of Bank Reserves, on deposit at the Federal Reserve, the transactions only occur between member banks. The only role that the Fed plays in this market consists of transferring reserve balances from one bank's account to another.

When the Fed attempts to influence rates in the Fed Funds market, they do so by injecting or extracting reserves through the activities of the Federal Open Market Committee, which I will discuss later.

Briefly, overnight loan transactions occur in the Fed Funds market when banks with excess reserves sell some of those excesses to banks that do not have adequate reserve balances.

Some transactions occur between banks with excess reserves simply to take advantage of interest rate differentials that occur throughout the market. But, the primary purpose of the Federal Funds Market remains to allow banks to borrow reserve dollars to cover insufficient reserve balances.

 

An example, more than words, will clarify the transactions in the Fed Funds market. Before we look at the example,…