- The federal funds rate is set by the Federal Reserve and is used by banks to borrow money overnight.
- Changes in the federal funds rate influence the interest rates on loans, credit cards, and bank accounts.
- The Fed most recently cut interest rates by a quarter percentage point for a target range of 4.25% to 4.50%.
The major mandate of the Federal Reserve is to keep the US financial system solvent and manage the amount of cash and readily available funds in circulation. It does so by lowering and raising interest ratest — specifically one called the federal funds rate.
The federal funds rate, or fed funds rate, is the interest rate set by the Federal Open Markets Committee. After the Fed sets it, the federal funds rate becomes a basis for interest charged on loans and credit card purchases and the return offered by fixed-income investments such as bonds and annuities.
The federal funds rate impacts other interest rates set by financial firms, banks, and the best online brokerages.
On December 18, the Federal Reserve lowered its benchmark interest rate by 25 basis points, setting the new target range at 4.25% to 4.50%.
How the federal funds rate works
The Federal Open Market Committee sets the rate to guide banks' charging practices. Made up of the Fed's Board of Governors and five regional Federal Reserve Bank presidents, the FOMC meets at least eight times a year to decide the federal funds rate based on prevailing economic conditions.
The Federal Reserve lowered the federal funds rate three times in 2024 to slow aggressive inflation and prevent a recession.
Bank reserves
The Fed mandates activity between banks to ensure they meet their reserve requirements. Each bank must maintain enough cash on hand, plus a reserve balance with the central bank, to cover a certain percentage of its deposits and other liabilities on every business day.
These regulations ensure that a bank's account holders always have ready access to their money. If banks are short on funds to maintain their reserve requirement, they borrow from another — at (or very close to) the fed funds rate.
Overnight lending
The federal funds rate, or the overnight lending rate, is the interest commercial banks charge when they lend money to one another for extremely short-term periods — literally, overnight.
Federal fund effective rate
The effective federal funds rate is the volume-weighted median of overnight rates banks pay when they borrow from other banks in the country. As of December 18, it was 4.50%.
Federal funds target rate
The federal funds target rate is the range set by the Federal Reserve based on the sum of the inflation rate and equilibrium rate adjusted for an inflation gap and output gap. As of December 19, the federal funds target rate was 4.25% to 4.50%.
Influence on other rates
How cheap or expensive it is to borrow money affects business and consumer spending. So, the Fed adjusts the federal funds rate to keep the entire economy on course. The prime rate is one of the major rates impacted by the federal fund rate.
Other rates influenced by the fed rate are:
- Personal loans
- Mortgage loans
- Credit card annual percentage rate (APR)
- Car loans
- CDs
The federal funds rate and the economy
During its eight meetings a year, the FOMC can raise, lower, or keep the fed funds rate the same. But what motivates the committee to change it periodically? How does the Fed use it as an economy-adjusting tool?
Stimulating growth
When it needs to stimulate economic growth — production, spending, expansion — the Fed lowers the fed funds rate. This move makes it cheaper for banks to borrow and maintain their reserves. So these banks can then lend out their extra funds at lower costs, encouraging companies and individuals to borrow to expand, invest, and buy things.
Controlling inflation
When the Fed needs to slow down the economy because prices are climbing too fast and causing rampant inflation, the Fed raises the Fed funds rate. Member banks must pay more interest to prevent their required reserve balance from going into the red.
They then raise their interest rates to clients, which tends to slow down borrowing activity. When banks don't finance as much, the money supply contracts and economic growth returns more sustainably.
How the federal funds rate affects you
The federal funds rate is an interbank interest rate. But it has a ripple effect throughout people's financial lives, the interest they pay, and the money they earn.
Borrowing costs
The movement of the Fed funds rate influences the movement of several borrowing rates, including interest rates on loans and credit cards.
The prime rate is the rate a bank can offer its best corporate or high-net-worth individual clients. A shift in the prime rate also influences consumer interest rates. When the prime rate rises or drops, you can expect a corresponding adjustment on the monthly charges of your personal loans, credit cards, and adjustable-rate mortgages.
Savings rates
Changes in the federal fund rate and the prime rate also affect savings rates on interest-earning accounts like bank accounts, CDs, and high-yield savings accounts. When the federal fund rate goes down, so do consumer saving rates.
Economic impact
Changes in the fed funds rate can be paralleled in the interest rates paid by newly issued Treasury notes and bonds. These, in turn, serve as a benchmark for corporate bond rates. A decrease in the fed funds rate can also send stocks soaring, while an increase can push the market to decline.
Rates may also affect employment. Consumers are encouraged to buy more goods and services when interest rates decrease. This propels businesses to meet demand by expanding production, hiring more workers, and raising wages.
Current federal funds rate and recent trends
On December 18, the Federal Reserve cut interest rates, the third rate cut in 2024. Fed chair Jerome Powell said the cut was "the best decision" to achieve the Fed's mandate of maximum employment and price stability. Powell has said the Fed should move cautiously on cutting rates in 2025.
The Federal Reserve meets eight times a year. The next Fed meeting is January 28 and 29, 2025.
FAQs about the federal funds rate
The Federal Open Market Committee (FOMC), the Fed's monetary policy-making body, sets the federal funds rate. Members meet once every six weeks to discuss economic conditions and decide whether to increase, decrease, or leave the federal funds rate unchanged.
The federal funds rate may change multiple times a year or not change for several years. The Federal Reserve analyzes economic growth and activity, meeting eight times yearly to determine whether rates should be raised or lowered.
The Federal Reserve changes the federal funds rate to stimulate economic activity, manage consumer rates, and combat inflation. The Fed will increase, decrease, or keep the rate the same depending on economic activity and projections.
