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The federal funds rate is one of the Federal Reserve’s key tools for guiding U.S. monetary policy. It impacts everything from the annual percentage yields you earn on savings accounts to the rate you pay on credit card balances, which means the fed funds rate effectively dictates the cost of money in the U.S. economy.
How Does the Federal Funds Rate Work?
The Federal Open Markets Committee sets the federal funds rate—also known as the federal funds target rate or the fed funds rate—to guide overnight lending among U.S. banks. It’s setas a range between an upper and lower limit.
The federal funds rate is currently 5.25% to 5.50%.
Here’s how it works: Customers deposit money at banks, and those deposits provide banks with the capital needed for extending loans and other forms of credit to their customers. Regulators require that banks and other depository institutions keep a certain percentage of their total capital in reserve, to help guarantee their stability and solvency.
Read More: Federal Funds Rate History 1990 to 2023
The amount of capital held by banks fluctuates day to day as deposits are added and withdrawn, and loans are approved and repaid. This means their reserve requirements are also constantly changing.
Banks often need to borrow money from other financial institutions overnight to meet regulators’ reserve requirements—or they may end up with excess reserve capital to lend out to their peers. The federal funds rate provides a reference for institutions as they are borrowing or lending reserves.
The Federal Funds Rate and Monetary Policy
Congress has assigned the Federal Reserve two jobs, commonly known as its “dual mandate”: Maintain stable prices throughout the economy—a.k.a. keep inflation under control—and support maximum employment. In addition, it’s expected to help maintain moderate long-term interest rates and a stable financial system.
Fed funds is a key tool that lets the central bank manage the supply of money in the economy. That’s because it influences what banks charge each other, which informs the rates they charge you and their other customers.
Take the prime rate, a benchmark for consumer and business loans. The prime rate closely tracks changes to fed funds as banks pass on the changing costs they pay to meet reserve requirements.
When the Fed raises the fed funds rate, it’s aiming to boost short-term borrowing costs throughout the economy. This in turn reduces the supply of credit and makes loans more expensive for everyone. This can quell rising inflation by reducing the amount of money flowing through the economy.
Lowering the fed funds rate has the opposite effect. It reduces short-term interest rates throughout the economy, increasing the supply of money and making it cheaper to get credit. This may cause moments of low or negative inflation to turn around and may drive hiring as companies are able to grow more cheaply.
How the Fed Funds Rate Impacts the Economy
The federal funds rate doesn’t just impact interest rates, though. Its impact can be felt throughout the economy.
Expectations regarding changes to the fed funds rate in the months and years ahead are a key factor in the movement of Treasury yields, on which many other forms of business, government and mortgage-backed credit are priced.
The stock market is also very sensitive to changes in the federal funds rate. When the Fed cuts rates, for instance, stock markets typically spike higher since the borrowing costs for public companies should fall, making it cheaper to expand their businesses and boost earnings.
When rates rise, though, equity markets may struggle more as borrowing becomes more expensive and lenders are rewarded with higher rates.
The Federal Funds Rate Throughout History
The fed funds rate is dynamic, rising and falling as the Fed responds to changes in the economy. The FOMC holds eight policy meetings every year, at which they survey the economic landscape and vote on whether to hold fed funds steady or change the rate.
Over the last 50 years, the federal funds rate has ranged from a low of 0% to a high of 20% as the FOMC attempted to manage the economy.
- Fed Funds Rate High: 20%. In 1980, feds fund soared to 20% to battle double-digit inflation. Higher interest rates typically curb borrowing and spending as the cost of accessing lending and credit rise for consumers and businesses.
- Fed Fund Rate Low: 0%. In 2008, the Federal Reserve lowered the fed funds rate to 0%, to revive the economy during the Great Recession. It did so once again in 2020 to minimize the economic fallout from the Covid-19 crisis. Lower rates make lending and credit easier for borrowers to get, which spurs consumer and business spending and grows the economy.
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FAQs
The federal funds rate, or Fed rate, is the interest rate that U.S. banks pay one another to borrow or loan money overnight. It also affects interest rates on everyday consumer products, such as credit cards or mortgages.
What does the federal funds rate tell us? ›
The Federal Reserve determines the price of borrowing money through one of its primary interest rates, the fed funds rate. The fed funds rate influences various financial decisions and products, such as credit card rates and mortgage rates.
Is a higher federal funds rate better? ›
When the Fed raises the fed funds rate, it's aiming to boost short-term borrowing costs throughout the economy. This in turn reduces the supply of credit and makes loans more expensive for everyone. This can quell rising inflation by reducing the amount of money flowing through the economy.
What happens when the federal funds rate is high? ›
When the Fed increases the federal funds rate, it typically pushes interest rates higher overall, which makes it more expensive for businesses and individuals to borrow. The higher rates also promote saving.
How does increasing the federal funds rate affect the economy? ›
The higher the federal funds rate, the more expensive it is for banks, businesses and consumers to borrow money. This encourages them to spend less money, slowing the economy. When the rate is cut, they are more likely to spend, stimulating the economy.
Who uses the Fed funds rate and for what reason? ›
The federal funds rate helps the U.S. Federal Reserve influence interest rates and borrowing. It can also be called the fed funds rate, federal interest rate or federal reserve rate. The federal funds rate may also impact the interest rate that you're charged on your home mortgage or personal loan.
What is the goal of the federal funds rate? ›
The Fed meets eight times each year to discuss whether to keep the federal funds rate steady or adjust it. The committee increased its benchmark rate 11 times between March 2022 and July 2023 in an effort to cool inflation. Since then, it's remained steady at 5.25–5.5%, a 23-year high.
What is the highest the federal funds rate has ever been? ›
The highest the federal funds rate has ever soared was to 20% in December 1980.
What is the current Fed interest rate today? ›
What is the current Fed interest rate? Right now, the Fed interest rate is 5.25% to 5.50%. The FOMC established that rate in late July 2023.
What happens to the stock market when the Fed raises interest rates? ›
The Bottom Line
As a general rule of thumb, when the Federal Reserve cuts interest rates, it causes the stock market to go up; when the Federal Reserve raises interest rates, it causes the stock market to go down. But there is no guarantee as to how the market will react to any given interest rate change.
When the Federal Reserve increases the federal funds rate, it typically increases interest rates throughout the economy, which tends to make the dollar stronger. The higher yields attract investment capital from investors abroad seeking higher returns on bonds and interest-rate products.
What happens to inflation when federal funds rate increases? ›
When the central bank increases interest rates, borrowing becomes more expensive. In this environment, both consumers and businesses might think twice about taking out loans for major purchases or investments. This slows down spending, typically lowering overall demand and hopefully reducing inflation.
How do Fed rates affect mortgage rates? ›
Because the Fed's rate decisions serve as a basis for savings instruments, raising or lowering the fed funds rate can push the SOFR up or down. ARM rates, in turn, go up or down as well when the rate resets. All this means that, if the fed funds rate goes up, your ARM rate will increase as well at the next adjustment.
What happens to the federal funds rate when there is a recession? ›
Rates drops are more common in the early stages of a recession. As the economy begins to pick up, the Federal Reserve may adjust its interest rate policy. Once the economy begins to approach the peak of an expansion period, the Fed may raise rates in order to curb borrowing and spending.
Where to put your cash after the Fed's interest rate increase? ›
Since savers don't know which way rates will move next, advisers often recommend a CD ladder. This means buying a series of CDs with progressively later maturity dates. Laddering ensures that some portion of your savings matures each year and can be spent or moved into other investments as rates change.
How to profit from rising interest rates? ›
8 money moves to make as interest rates remain high
- In a nutshell. ...
- Search for banks with the best savings accounts. ...
- Keep an eye on credit card interest. ...
- Refinance a mortgage (it's not too late) ...
- Invest in stocks. ...
- Consider Treasury Inflation-Protected Securities (TIPS) ...
- Buy short-term bonds instead of long-term bonds.
Key Takeaways
When the Federal Reserve increases the federal funds rate, it typically increases interest rates throughout the economy, which tends to make the dollar stronger. The higher yields attract investment capital from investors abroad seeking higher returns on bonds and interest-rate products.
Why does the real federal funds rate matter to stock prices? ›
A monetary easing, i.e., a decrease in the federal funds rate, will increase the level of activity in the economy as a whole, which in turn raises firm's profits, increasing dividends and causing stock prices to rise.
What does the federal funds rate refer to quizlet? ›
The "Federal funds rate" refers to the. b) Interest rate on interbank borrowing of bank reserves at the Fed.
How does the Fed funds rate affect mortgage rates? ›
Bottom line. The Federal Reserve doesn't directly set mortgage rates. However, it can influence mortgage interest rates by adjusting the federal funds rate and buying or selling bonds and mortgage-backed securities.
