Federal Funds Rate: Definition & Its Impact

The federal funds rate is the benchmark interest rate at which banks lend each other money. It has a direct bearing on many other rates and is the concept we're talking about when we say, "The Fed lowered rates today."

As we've seen throughout the past two decades, disasters can and do happen -- sometimes for no particular reason -- and the Fed will use the tools at its disposal to calm the economy while stimulating investment. The federal funds rate is one of those tools.

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Slips of paper with various percentages written on them and a single slip with a question mark in the center. — Image source: Getty Images.

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Interest Rate

An interest rate is the cost of borrowing money or the premium you get for lending money. Learn how interest rates affect the economy.

At its meeting on July 26, 2023, the Federal Reserve raised the federal funds rate by 0.25%, setting it between 5.25% and 5.5%. This range is used to influence a number of other important interest rates we see in daily life. The increase marked its highest level in more than 20 years.

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Federal Reserve

The Federal Reserve, often referred to as “the Fed,” is the central bank of the United States.

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Effective Federal Funds Rate Chart — Effective Federal Funds Rate data by YCharts.

Simply by considering some of the major events of the past several decades, we can get clues about how and why the federal funds rate has moved as it has. In the mid-2000s, interest rates had begun to rise rapidly, but the housing and financial crisis abruptly brought rates to zero for almost 10 more years.

As rates slowly began to rise again in 2018, the coronavirus pandemic quickly shut the door and brought rates down quickly. Meanwhile, recent surging inflation has caused the Federal Reserve to drive rates higher again.

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About the Author

Matt DiLallo has been a contributing Motley Fool stock market analyst specializing in covering dividend-paying companies, particularly in the energy and REIT sectors, since 2012. He also covers pre-IPO companies, ETFs, and other investing topics. He holds an MBA from Liberty University.

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