The federal funds rate is the target interest rate range set by the Federal Reserve that determines what banks charge each other for overnight loans of excess reserves, and it ripples outward into everything from credit card bills to mortgage quotes and stock prices.
At a Glance
- The Federal Open Market Committee sets the federal funds rate target eight times a year based on economic data.
- Banks use this rate to lend each other excess reserves overnight to meet reserve requirements.
- The rate indirectly shapes consumer borrowing costs on mortgages, auto loans, and credit cards through the prime rate.
- On December 18, 2024, the Fed cut the rate by 25 basis points to a range of 4.25% to 4.50%, its first cut in over four years.
- Stock markets tend to react sharply to even small changes in the target rate.
What the Rate Actually Measures
Banks are required by law to hold a reserve at a Federal Reserve bank equal to a set percentage of their deposits. When a bank ends up with more cash in that account than it needs, it can lend the surplus overnight to another bank that is short. The price of that overnight loan is the federal funds rate, sometimes just called the fed funds rate.
Regulators check whether a bank is meeting its reserve requirement by averaging its end of day balances over a two week maintenance period. A bank expecting to finish above its requirement can lend the extra to one expecting to finish below. That borrowing and lending between banks, purely to square up reserve balances overnight, is what sets this particular rate apart from other interest rates in the economy.
How the Fed Sets and Moves the Target
The Federal Open Market Committee meets eight times a year to set a target range for the federal funds rate, then uses its policy tools to steer the actual rate banks charge each other into that range. The committee looks at a mix of indicators, including the core inflation rate and durable goods orders, to judge whether the economy needs cheaper credit, tighter credit, or no change at all.
The FOMC has three basic options at each meeting:
- Cutting the rate: Used to stimulate growth or head off rising unemployment by making borrowing cheaper across the economy.
- Raising the rate: Used to cool an overheating economy or fight inflation by making borrowing more expensive and saving more attractive.
- Holding steady: Used when conditions look stable enough that no adjustment is warranted for the time being.
A quarter point move, or 25 basis points, is the standard adjustment, though the committee has moved by 50 basis points or more when it judged the situation urgent.
A Look Back at How Far the Rate Has Swung
The federal funds rate target has covered enormous ground over the decades. It climbed as high as 20% in the early 1980s as the Fed battled runaway inflation. After the 2008 financial crisis, it dropped to a range of 0% to 0.25% and stayed there for years as the Fed tried to nurse the economy back to health. That same rock bottom range, 0% to 0.25%, was still in place in March 2020 at the start of the pandemic.
Starting in 2022, the Fed reversed course and began raising rates steadily to fight a surge in inflation, a campaign that carried into 2024. That long climb set the stage for the December 18, 2024 cut, which brought the range down to 4.25% to 4.50% and marked the first reduction in more than four years.
Comparing How the Rate Moves and What It Signals
| Policy stance | Typical trigger | Effect on borrowing | Recent example |
|---|---|---|---|
| Cutting the rate | Slowing growth, rising unemployment risk | Cheaper loans, more spending and investment | 25 basis point cut to 4.25% to 4.50% in December 2024 |
| Raising the rate | High or rising inflation | Costlier loans, more incentive to save | Steady increases starting in 2022 into 2024 |
| Holding steady | Stable growth and inflation near target | No immediate change to borrowing costs | Extended pauses between major policy shifts |
Why the Rate Matters Beyond the Banking System
The federal funds rate touches the broader economy mainly through the prime rate, the rate banks charge their most creditworthy customers. Lenders often peg mortgage rates, auto loan rates, and credit card rates to that prime rate, so a Fed move ripples into consumer borrowing costs even though no consumer ever borrows directly at the federal funds rate itself.
Investors track the rate closely because stocks tend to move sharply on even modest changes. A small cut can lower borrowing costs for companies and send share prices climbing, which is why analysts parse every word from FOMC members trying to anticipate where the target rate is headed next.
Which Sectors Feel It Most
- Real estate: Mortgage rates generally track the federal funds rate, shaping home buying and refinancing activity.
- Automotive: Car loan rates follow the same trend, affecting vehicle sales.
- Consumer lending: Credit card and personal loan rates shift as the target rate changes.
- Corporate investment: Lower rates tend to encourage business expansion; higher rates tend to discourage it.
- Foreign exchange: Rate changes can move the dollar's value against other currencies, affecting trade and investment.
- Government finance: The rate influences how much it costs the government to borrow, which can affect deficits.
- Financial markets: Stock prices react to rate changes partly because they affect corporate profits and investor sentiment.
How This Differs From Other Interest Rates
People sometimes use
