Federal Funds Rate is the rate at which banks and credit unions lend their reserves to other banks or credit unions on overnight basis without having a collateral requirement. Federal Funds rate is lending rate among banks.

From the graph we see that federal funds rate was at its peak during the period of 1980s. This period coincides with period of high inflation in US economy. During the time when interest rates are high, people and institutions are reluctant to borrow due to high cost of capital. Depositors on the other hand, are willing to save a higher amount as they get a higher rate of return. Both these effects result in reducing money circulation in the economy. As a result, people spend less on goods and demands for goods decreases. As demand decreases, the price of goods also reduces. As a result inflation reduces. So, Fed maintains high funds rate to control inflation in periods of high inflation.

From the graph we see that federal funds rate are decreasing during every recession. During recession , banks lower their lending rate to encourage people and institutions to borrow funds. Depositors on the other hand, are unwilling to save a higher amount as they get a lower rate of return. Both these effects result in increasing money circulation in the economy. As a result, people spend more on goods and demands for goods increases. As demand increases, organizations borrow funds to expand their existing manufacturing capacities to meet the growing demand. It is beneficial for organizations to borrow funds as cost of capital is low. This results in higher employment. To conclude, Fed lowers Federal funds rate during recessions to stimulate economy.