Interest Rates
What Is the Federal Funds Rate? How the Fed Sets Interest Rates
The federal funds rate is the interest rate banks charge each other for overnight loans. It's the Federal Reserve's primary tool for controlling inflation and influencing the economy.
The federal funds rate is the target interest rate set by the Federal Open Market Committee (FOMC) at which banks lend reserve balances to each other overnight. It's the most important interest rate in the world because it influences all other borrowing costs across the economy.
How the Fed Funds Rate Affects the Economy
When the Fed raises the funds rate, borrowing becomes more expensive throughout the economy. Mortgage rates rise, credit card rates increase, business loans cost more, and consumer spending slows. This is how the Fed fights inflation — by reducing demand. When the Fed cuts rates, the opposite occurs: borrowing becomes cheaper, stimulating spending and investment.
The FOMC Meeting Schedule
The FOMC meets 8 times per year (roughly every 6 weeks) to assess economic conditions and set the target rate. Each meeting produces a statement and economic projections; the chair holds a press conference after every meeting. Markets closely watch the "dot plot" — individual FOMC members' rate projections for the next several years.
Fed Funds Rate vs. Other Rates
The fed funds rate directly influences short-term rates: savings accounts, money market funds, adjustable-rate mortgages, and short-term business loans. Long-term rates (10-year Treasury, 30-year mortgages) are influenced by inflation expectations and economic outlook, not just the current fed funds rate. This is why long-term rates sometimes move opposite to the fed funds rate.
Historical Context
The fed funds rate has ranged from near 0% (2008-2015, 2020-2022) to over 20% (1981, when Volcker fought double-digit inflation). The current rate environment should be compared against the long-term average of approximately 5%.
Related Indicators
All Indicators →Related Guides
All Guides →Inflation Explained
Inflation measures the rate at which prices rise across the economy. Understanding CPI vs. PCE and core vs. headline inflation is essential for pricing, wage, and investment decisions.
Yield Curve Explained
The yield curve plots Treasury bond yields across different maturities. When it inverts (short-term rates exceed long-term rates), it has historically predicted every U.S. recession.
How Mortgage Rates Work
Mortgage rates are driven by the 10-year Treasury yield, inflation expectations, and the mortgage-backed securities market — not the federal funds rate directly.
Primary Sources
Frequently Asked Questions
How often does the Fed change interest rates?
The FOMC meets 8 times per year but doesn't necessarily change rates at every meeting. In a tightening or easing cycle, the Fed typically moves in 25 basis point (0.25%) increments, though it has used 50bp and 75bp moves during aggressive cycles. In stable periods, the rate may hold for months or years.
Does the Fed control mortgage rates?
Not directly. The Fed controls the overnight lending rate between banks. Mortgage rates are primarily driven by the 10-year Treasury yield, which reflects market expectations about inflation, economic growth, and future Fed policy. When the Fed raises rates to fight inflation, it may actually cause long-term rates to fall if markets believe the action will successfully contain prices.
What is the neutral rate?
The neutral rate (r-star) is the theoretical federal funds rate that neither stimulates nor restricts economic growth. Most economists estimate it at roughly 2.5-3% in nominal terms. When the actual rate is above neutral, monetary policy is restrictive; below neutral, it is accommodative.