The overnight rate, also known as the federal funds rate in the United States, is the interest rate at which banks lend and borrow money among themselves on an overnight basis. It is a key monetary policy tool used by central banks to influence the overall level of interest rates and control the money supply in the economy.
The central bank, such as the Federal Reserve in the United States or the Bank of Canada, sets the overnight rate. This rate has a significant impact on various financial markets and the broader economy because it influences the cost of borrowing for banks. When the central bank raises the overnight rate, it becomes more expensive for banks to borrow money, which can lead to higher interest rates for consumers and businesses. Conversely, when the central bank lowers the overnight rate, it becomes cheaper for banks to borrow, potentially resulting in lower interest rates for borrowers.
The overnight rate is a critical tool for central banks in implementing their monetary policy objectives, such as controlling inflation and stabilizing the economy. It serves as a benchmark for other interest rates in the financial system.