What is the federal funds rate?
Quick insights
- The federal funds rate is the interest rate at which banks lend cash reserves to each other overnight.
- Lowering the federal funds rate can stimulate economic growth, while raising it can help control inflation.
- Higher rates generally lead to more expensive borrowing (higher interest on debt). Lower rates can reduce borrowing costs, increase savings yields and possibly stimulate the economy.
The federal funds rate is one of the government’s primary tools for influencing economic activity in the United States. People pay attention to the rate for a variety of reasons, mainly because it’s important to personal finances. The federal funds rate influences inflation and the average interest rates available on loans, for example. Before we get to all that, though, let’s start with the basics.
What is the federal funds rate?
The federal funds rate is the interest rate at which financial institutions lend reserves to other institutions overnight. Set by the Federal Reserve, the federal funds rate influences overall economic activity. Changes in the rate often impact inflation, interest rates and employment. One way to think of the federal funds rate is as the government’s way of setting a financial tone for the economy.
The role of the Federal Reserve in setting the federal funds rate
The Federal Reserve (nicknamed “the Fed”) refers to the bank of the United States. The Fed’s adjustments to the federal funds rate are meant to promote stable prices, maximum employment and moderate longterm interest rates. The rate is a key tool for implementing monetary policy and managing economic conditions.
How does the federal funds rate affect interest rates?
The federal funds rate influences other interest rates in the economy, such as mortgage rates and savings account yields. Adjusting interest rates is one of the main tools used to achieve the Fed’s goals. Lower federal funds rates, for instance, can stimulate economic activity by lowering borrowing costs for consumers and businesses.
What happens when the federal funds rate is high?
When the federal funds rate rises, borrowing costs for banks increase. This typically leads them to set higher interest rates on loans and credit for consumers and businesses. As a result, more interest accrues on loans and lines of credit, so it’s more expensive to borrow money. Therefore, a higher federal funds rate influences borrowing behavior, along with the effects of inflation.
How important is the federal funds rate to personal finances?
The federal funds rate tends to affect personal finance decisions because rate changes influence interest rates on loans, credit cards and savings accounts. This is because changes in the rate can affect borrowing costs, saving yields and overall financial conditions.
How you budget, manage debt, save and invest could change based on the federal funds rate. For example, the Annual Percentage Yield (APY) available on a savings account might increase. This could entice you to make additional or larger deposits to your savings account than you would otherwise.
Where can I find the federal funds rate?
You can find official updates on the federal funds rate and its effects on interest rates from the following sources:
- Federal Reserve Board: Provides official announcements, minutes of meetings, and reports on monetary policy.
- Federal Reserve Bank of New York: Offers detailed data and analysis on the federal funds rate and related economic indicators.
- Federal Reserve Economic Data: A comprehensive database of economic data, including the federal funds rate.
What is the highest the federal funds rate has ever been?
According to the Federal Reserve Economic Data (FRED), the federal funds rate peaked at 22% in December 1980. The federal funds rate has been known to change quite dramatically over time due to macroeconomic conditions and related factors.
In summary
The federal funds rate influences domestic economic conditions in the United States. The rate has a significant effect on personal finances because it affects interest rates on loans, mortgages and savings accounts. In general, when the federal funds rate is high, overall spending tends to get quiet and reserved. If the rate is low, everyone could be borrowing and spending more.
