What are Fed Funds?

Fed Funds, or Federal Funds, refer specifically to overnight loans between banks, where excess reserves held by a commercial bank are lent to another bank at an interest rate known as the Federal Funds Rate. These transactions occur in the interbank market and are pivotal for maintaining the liquidity necessary for the banking system.

When a commercial bank has more deposits than it needs to meet its reserve requirements, it can deposit those excess funds in its local Federal Reserve Bank. If other banks need funds to meet their reserve requirements, they can borrow these excess reserves. This process helps maintain balance in the monetary supply and ensures that banks can meet their obligations. Thus, the option that describes deposits made by a commercial bank in its local Federal Reserve Bank accurately captures the essence of Fed Funds. The relationship between banks and the Federal Reserve is crucial in the management of monetary policy and liquidity in the banking system.