US & World Economies US Economy GDP Growth & Recessions Current Federal Reserve Interest Rates and Why They Change The Fed raises and lowers rates to affect borrowing, and the economy By Kimberly Amadeo Kimberly Amadeo Kimberly Amadeo is an expert on U.S. and world economies and investing, with over 20 years of experience in economic analysis and business strategy. She is the President of the economic website World Money Watch. As a writer for The Balance, Kimberly provides insight on the state of the present-day economy, as well as past events that have had a lasting impact. learn about our editorial policies Updated on November 2, 2022 Reviewed by Robert C. Kelly Reviewed by Robert C. Kelly Robert Kelly is managing director of XTS Energy LLC, and has more than three decades of experience as a business executive. He is a professor of economics and has raised more than $4.5 billion in investment capital. learn about our financial review board Fact checked by Lars Peterson Fact checked by Lars Peterson Website Lars Peterson is a veteran personal finance writer and editor with broad experience covering personal finance, particularly credit cards, banking products, and mortgages. He has been writing and editing for more than 20 years and has a knack for digging deep into a subject so he can make it easier for others to understand. As an editor for The Balance, he has assigned, edited, and fact-checked hundreds of articles. learn about our editorial policies In This Article View All In This Article Why Federal Reserve Interest Rates Matter to You How the Fed Funds Rate Works Frequently Asked Questions (FAQs) Photo: Samuel Corum / Getty Images The fed funds rate is the primary tool the Federal Reserve uses to influence the U.S. economy and is closely tied to the U.S. economic outlook. It directly influences prevailing interest rates such as the prime rate and affects what consumers are charged on credit cards, personal loans, and mortgages. The fed funds rate is the interest rate banks charge each other to lend Federal Reserve funds overnight. The nation's central bank uses it in addition to other tools to promote economic stability by raising or lowering the cost of borrowing. The nation's central bank uses its Federal Open Market Committee (FOMC) to make decisions about interest rates. It meets eight times per year to discuss current conditions and decide what actions to take. By the Numbers In November, the Federal Reserve announced that it would raise interest rates by 0.75 percentage points, shifting the target range to 3.75%-4%.During the Covid-19 pandemic, the interest rate was kept at a near-zero range but has risen sharply in response to surging inflation.The fed funds rate directly influences prevailing interest rates such as the prime rate and what consumers are charged on credit cards, auto and personal loans, and even mortgages. Why Federal Reserve Interest Rates Matter to You The Federal Reserve's goal is to promote maximum employment, stable prices, and moderate long-term interest rates. The Fed uses interest rates as a lever to grow the economy or put the brakes on it. If the economy is slowing, the Fed lowers interest rates to make it cheaper for businesses to borrow money, invest, and create jobs. Lower interest rates also allow consumers to borrow and spend more, which also helps spur the economy. On the other hand, if the economy is growing too fast and inflation is heating up, the Fed is likely to raise interest rates to curtail spending and borrowing. For those of us who live in the economy, the Fed's interest rate moves affect our borrowing costs. If the Fed's moves are successful, we may enjoy a robust economy, with plenty of jobs. And if not, we may be mired in recession. How the Fed Funds Rate Works The fed funds rate is one of the most significant leading economic indicators in the world. Its importance is psychological as well as financial. The FOMC targets a specific level for the fed funds rate and uses a couple of tools to reach it. In one, the Federal Reserve pays interest to banks on funds that certain banks deposit with the central bank, called "Interest on Reserve Balances." This rate influences the interest rate the banks charge each other for short-term loans. Banks use these loans to help them manage their businesses. Note Along with cutting its benchmark rate, the Fed lowered the reserve requirement to 0% in March 2020, where it has remained. Managing the fed funds rate is no longer tied to banks' need to satisfy the reserve requirement. A lower federal funds rate encourages banks to lend more to households and businesses because they make more money from these loans than from lending each other their reserves. Traditionally, the Fed manages the fed funds rate with open market operations. It buys or sells U.S. government securities from Federal Reserve member banks. When the Fed buys securities, that purchase increases the reserves of the bank associated with the sale, which makes the bank more likely to lend. To attract borrowers, the bank lowers interest rates, including the rate it charges other banks. When the Fed sells a security, the opposite happens. Bank reserves fall, making the bank more likely to borrow and causing the fed funds rate to rise. These shifts in the fed funds rate ripple through the rest of the credit markets, influencing other short-term interest rates such as savings, bank loans, credit card interest rates, and adjustable-rate mortgages. The Fed's actions during the financial crisis sent banks’ reserve balances soaring. As a result, they no longer had to borrow from one another to meet reserve requirements. Frequently Asked Questions (FAQs) How are the federal funds rate and discount rate different? While the federal funds rate reflects the rate that banks charge each other for borrowing reserve funds, the discount rate is what the Federal Reserve charges its member banks to borrow funds directly from the Fed to cover temporary shortfalls. The fed funds rate is influenced by actions of the Federal Open Market Committee but is ultimately set by the market, and it varies slightly across the different Fed banks. The discount rate, on the other hand, is set by the Fed's board and is the same for every bank in the Fed. Why is the federal funds rate so influential on other interest rates? The fed funds rate affects other interest rates because it determines whether banks can make more money by lending to each other or by lending to other borrowers. When the fed funds rate is very low, banks will be better off lending to others. Although other rates will rise when the fed funds rate rises, fewer consumers and businesses will seek loans at those high rates, thus slowing down lending on the open market. Eventually, this will lead the Fed to lower the funds rate again, thus continuing the cycle. How does the federal funds rate affect the money supply? A lower fed funds rate will increase the money supply by encouraging more lending, borrowing, and business activity on the open market. A higher rate, on the other hand, discourages lending and decreases the money supply. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Board of Governors of the Federal Reserve System. "The Fed Explained: What the Central Bank Does," Pages 12-13. Board of Governors of the Federal Reserve System. "Federal Reserve Issues FOMC Statement." Board of Governors of the Federal Reserve System. "Reserve Requirements." Federal Reserve Bank of Philadelphia. "Implementing Monetary Policy in a Changing Federal Funds Market," Pages 15-16.