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Federal Funds Rate

Posted on October 16, 2025 by user

Federal Funds Rate

Key takeaways

  • The federal funds rate is the interest rate at which depository institutions lend reserve balances to one another overnight on an uncollateralized basis.
  • The Federal Open Market Committee (FOMC) sets a target range for that rate and meets regularly to adjust monetary policy.
  • Changes in the fed funds rate influence short-term borrowing costs across the economy—affecting mortgages, credit cards, business investment, the value of the dollar, and financial markets.

What the federal funds rate is

Banks are required to hold reserve balances at Federal Reserve banks equal to a percentage of deposits. When a bank has more reserves than required, it can lend the excess overnight to another bank that falls short. The interest charged on these overnight loans is the federal funds rate (often shortened to “fed funds rate”).

The FOMC sets a target range for the federal funds rate as a primary tool of U.S. monetary policy. The effective rate in the market is guided into that target range using the Fed’s policy tools.

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How the rate is adjusted

The FOMC meets several times a year (commonly eight scheduled meetings) to assess economic conditions and set the target range. The committee adjusts the target to pursue its dual mandate of maximum employment and stable prices:

  • Lowering the target rate: stimulates growth by making borrowing cheaper, encouraging spending and investment.
  • Raising the target rate: cools inflationary pressures by making borrowing more expensive, encouraging saving and reducing demand.
  • Holding the rate steady: used when economic conditions are stable.

The Fed uses tools such as open market operations, management of its securities holdings, and rates on reserve balances and reverse repurchase agreements to steer the effective federal funds rate toward the target.

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Recent policy context (examples)

Policy has varied in response to changing economic conditions:
* Following record-low rates after the 2008 crisis and during early 2020, the Fed held rates near zero to support recovery.
From 2022 into 2023 the Fed raised its target range to combat rising inflation (peaking around the mid-2023 range).
In late 2024 the FOMC moved to lower its target range in a series of reductions as inflation showed signs of moderating.

These moves illustrate how the Fed shifts policy to respond to inflation, employment trends, and financial stability risks.

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Why it matters — economic and market effects

The federal funds rate is a benchmark that affects monetary and financial conditions across the economy:

  • Consumer borrowing: influences short-term rates on credit cards, personal loans, and—indirectly—mortgage rates.
  • Business investment: lower rates reduce financing costs and can spur capital spending; higher rates tend to restrain expansion.
  • Banking sector: banks use the fed funds rate as a reference for setting deposit and loan rates.
  • Financial markets: stock and bond markets respond quickly to changes or guidance because rate shifts alter corporate financing costs and discount rates for future earnings.
  • Exchange rates and government finance: rate changes affect the relative value of the dollar and the government’s cost of borrowing.

Sectors particularly affected

  • Banking and consumer lending (credit cards, personal loans)
  • Mortgage and real estate markets
  • Automotive financing and vehicle sales
  • Corporate capital investment and business borrowing
  • Financial markets and asset prices
  • International trade and exchange rates

How it affects consumers

Although the fed funds rate governs interbank overnight lending, its movements ripple through to consumers via the prime rate and other short-term rates. When the Fed lowers its target, borrowing typically becomes cheaper for households and businesses; when the Fed raises the target, borrowing costs generally rise.

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Frequently asked questions

How often does the FOMC set the target rate?
The FOMC meets regularly (commonly eight scheduled meetings per year) to review conditions and set policy.

Do banks pay or receive interest at the Fed?
The Federal Reserve pays interest on reserve balances held by depository institutions; it also uses tools like reverse repos to manage short-term liquidity and influence the market rate.

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Is the federal funds rate the same as other interest rates?
No. The fed funds rate is specifically the overnight interbank lending rate. Other rates (mortgages, corporate borrowing, consumer loans) are influenced by it but are determined by lenders and market conditions.

Bottom line

The federal funds rate is a central instrument of U.S. monetary policy and a key benchmark for short-term interest rates. FOMC decisions about the target range influence borrowing costs, economic growth, inflation, and financial markets—so changes and signals from the Fed are closely watched by households, businesses, and investors.

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Sources

Board of Governors of the Federal Reserve System; Federal Reserve Bank of St. Louis.

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