The Federal Funds Rate is the interest rate at which banks lend to each other overnight to meet their reserve requirements. Set by the Federal Reserve, it is one of the most critical tools in U.S. monetary policy, influencing liquidity in the banking system, the overall cost of borrowing, and the economy's health.

Banks are required to hold a certain percentage of their deposits in reserve, but they often borrow from one another to meet these requirements. The Federal Funds Rate is the rate at which this borrowing occurs, and the Federal Reserve uses it to control inflation and stabilize economic growth.

When the Fed raises the rate, borrowing becomes more expensive, which can cool off an overheating economy by reducing consumer spending and business investments. Conversely, lowering the rate makes borrowing cheaper, encouraging spending and investment to stimulate economic activity during a slowdown.

The Fed adjusts this rate through its Federal Open Market Committee (FOMC) meetings, based on economic conditions like inflation, employment, and GDP growth. Changes in the Fed Funds Rate ripple through the economy, affecting everything from mortgage rates and car loans to credit card interest rates and even the foreign exchange market.