What best describes the federal funds market?

• A. The market where banks borrow from households to meet loan demand.
• B. The market where foreign banks exchange currencies.
• C. The market where banks borrow from other banks to meet reserve requirements.
• D. The market for long-term government debt.

Answer: (C)

Interbank lending of reserve balances is the key idea here. Banks keep reserves at the Federal Reserve, and the federal funds market is where banks borrow and lend those reserves to each other, typically overnight, to meet reserve requirements and manage liquidity. The rate charged in these trades is the federal funds rate, a barometer for monetary policy and short-term liquidity conditions. This is why the description that matches is the one about banks borrowing from other banks to meet reserve requirements. It isn’t about households borrowing from banks, currency exchanges, or the market for long-term government debt.