These 12 banks are the heart of monetary policy

Pedestrians walk past the New York Federal Reserve building.
Scott Eells | Bloomberg | Getty Images

The fed funds market is where officials set what is probably the world's most important interest rate—yet very few people understand its current operations.

This is the market at which the Federal Reserve directs its primary energies.

The Federal Open Markets Committee targets a level or range for interest paid on overnight fed fund loans, which are dollar-denominated loans of U.S. dollars between financial institutions. The trading desk at the New York Fed buys or sells Fed funds in order to get fed funds to trade at the targeted level.

In the textbook narrative about the fed funds market, some banks borrow fed funds in order to meet their reserve requirements while other banks lend fed funds in order to earn a return on excess reserves. But this isn't quite right—and hasn't been right since the financial crisis struck, as a new note from the New York Fed shows.