The Federal Reserve interest rate, known as the federal funds rate, is the interest rate at which banks and credit unions borrow from and lend to each other. It's determined by the Federal Reserve and can be changed at any time. Changes to this rate impact consumers because they can influence the interest rates on credit cards, loans, and savings accounts to varying degrees.
Ultimately, the Federal Reserve interest rate is an important tool for maintaining a stable economy. Here's everything you need to know about Federal Reserve interest rates and how they impact your wallet.
What is the current federal reserve interest rate?
The current federal reserve interest rate, or federal funds rate, is 0% to 0.25% as of March 16, 2020. The federal reserve ordered two emergency decreases to the benchmark interest rate in March 2020 in response to the economic impact of the coronavirus (COVID-19) pandemic. On March 3, it was cut to 1.00% to 1.25%, and then again to 0% to 0.25% on March 16.
The table below shows the historical federal reserve interest rate dating back to 2015.
| Date | Federal Reserve Interest Rate |
|---|---|
| Mach 16, 2020 | 0%-0.25% |
| March 3, 2020 | 1.00%-1.25% |
| Oct. 31, 2019 | 1.50%-1.75% |
| Sept.19, 2019 | 1.75%-2.00% |
| Aug. 1, 2019 | 2.00%-2.25% |
| Dec. 20, 2018 | 2.25%-2.50% |
| Sept. 27, 2018 | 2.00%-2.25% |
| June 14, 2018 | 1.75%-2.00% |
| March 22, 2018 | 1.50%-1.75% |
| Dec. 14, 2017 | 1.25%-1.50% |
| June 15, 2017 | 1.00%-1.25% |
| March 16, 2017 | 0.75%-1.00% |
| Dec.15, 2016 | 0.50%-0.75% |
Source: The Federal Reserve.
Why does the Fed raise or lower the interest rate?
The Federal Reserve lowers interest rates in order to stimulate the economy leading up to and during economic downturns. It raises interest rates when the economy is strong in order to keep businesses and consumers in check.
The Federal Reserve exists to promote a safe and strong economy, which includes maintaining healthy employment rates, stable prices, and reasonable interest rates. The federal funds rate is one of the primary tools the Fed has at its disposal to do this. Adjustments in this rate aim to smooth the ups and downs of the economy, easing the severity of recessions and preventing economic booms that can lead to market crashes and excessive inflation.
Why the Federal Reserve cuts interest rates
When the Federal Reserve interest rate is low, there's more cash in circulation and banks are able to borrow from each other more freely. In turn, it becomes easier and more affordable for both consumers and businesses to borrow money, which boosts consumer spending and encourages businesses to expand, hiring more workers, and increasing wages.
This stimulates the economy and drives economic growth, making it an appropriate tool to prevent and ease severe economic downturns. That's why you'll typically see the Federal Reserve start to lower the interest rate when economists are concerned about an oncoming downturn, and then more aggressively in the midst of a downturn.
Why the Federal Reserve raises interest rates
When the Federal Reserve interest rate is high, banks are discouraged from borrowing from each other and the supply of cash in the economy decreases. This means consumers and banks are borrowing and spending less, which can cause the economy to slow down. The Federal Reserve typically raises the interest rate when the economy is strong.
It's easy to understand why the Federal Reserve would want to stimulate the economy, but it can be harder to understand why they might want to slow it down -- isn't economic growth good? Simply put, what goes up must come down, and the higher the economy climbs, the further it can fall. When rates are low and people feel good about the economy, consumers often take on excessive debt, and lenders may even lend too much money to unqualified borrowers. This leaves people, businesses, and banks in a precarious position when the economy inevitably slows down.
How the fed funds rate is set
The federal funds rate is set eight times per year by the Federal Reserve's Federal Open Market Committee (FOMC). In addition to these eight annual meetings, the FOMC can also call emergency meetings to immediately change the rate during times of crisis.
When the FOMC sets interest rates, they set a target rate rather than the actual interest rate, as they don't have direct control over interest rates. Once the target rate is set, the Federal Reserve engages in open market operations to hit that target. This entails buying and selling government securities such as treasury bills, bonds, and repurchase agreements in order to manipulate the supply of money in the economy, which in turn influences interest rates.
When the Fed buys up government securities, they inject money into the economy. Subsequently, banks have more cash on hand, and they decrease their interest rates to attract more borrowers. On the other hand, when the Fed sells government securities, they take money out of the economy. Banks then have less cash to lend, so they increase interest rates.
How other interest rates are determined
Credit cards and savings accounts are most sensitive to changes in the federal funds rate, followed by personal loans and auto loans, and finally, mortgage loans. The interest rates on all of these products are determined by other important factors, such as creditworthiness.
As the Federal Reserve interest rate is a short-term rate, changes in it have a stronger impact on short-term lending products. They also tend to have a bigger impact on products with variable, rather than fixed, interest rates.
Here's how banks set the interest rates on credit cards, loans, and savings accounts and how changes in the federal funds rate might affect you.
Credit card interest rates
Fluctuations in the federal funds rate have a direct impact on credit card interest rates. This is directly tied to the prime rate, which is the interest rate for customers with prime credit, and it's pegged at 3% above the federal funds rate.
Furthermore, since credit cards are the most short-term borrowing method, the rates will change almost immediately in response to federal funds rate changes. However, because interest rates on credit cards are relatively high, these changes -- for example, your APR going from 17.25% to 17.50% -- are often unnoticeable.
Personal loan interest rates
The interest rates on personal loans aren't directly tied to the prime rate or the federal funds rate, but they can be influenced by it. In other words, changes in the federal funds rate can eventually lead to changes to personal loan rates, but that correlation is neither as guaranteed nor as immediate as it is with credit cards.
What's more, many personal loans have fixed interest rates, meaning if you already have a personal loan, the rate will remain the same for the life of the loan -- regardless of how the fed funds rate changes. Loans with variable interest rates can fluctuate as the fed funds rate changes.
Auto loan interest rates
Like personal loans, auto loan interest rates aren't directly tied to the federal funds rate. However, they can be influenced by it, particularly because they're somewhat short term -- typically two to five years. The changes in auto loan rates are likely to be minimal though, as they're largely based on other factors like your credit score and the bond market.
Mortgage loan interest rates
Mortgage loans are one of the most long-term ways you can borrow money, so short-term interest rate changes aren't likely to affect them much. In fact, mortgage rates aren't directly tied to the federal funds rate -- they're set based on a variety of economic indicators, which can include the federal funds rate, but also include things like unemployment, inflation, and the bond market.
Savings account interest rates
Interest rates on savings accounts are fairly responsive to changes in the federal funds rate. When interest rates are cut, banks are likely to cut the APYs offered by their savings accounts fairly quickly in order to protect their profits. Increases in the federal funds rate usually lead to less dramatic and immediate increases in savings account rates, but a rising rate environment is still advantageous for savers.
The Federal Reserve interest rate is an important tool for guiding the economy. Increases in the federal funds rate can protect a strong economy, while cuts to the federal funds rate can help cushion the fall for a declining economy. These changes can impact your wallet -- low interest rates are good for borrowers, while high interest rates are good for savers. Ultimately, though, it's your own money habits that are the main factor in determining your financial future.
About the Author
Elizabeth is a personal finance writer specializing in credit cards, debt repayment, and small business. Her work has appeared on The Motley Fool, MSN Money, Yahoo! Finance, and Business Insider. She’s an avid credit card points collector and perpetual traveler currently living in Costa Rica.
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