Federal funds rate 101: How it works, who sets it and why it changes

The federal funds rate is one of the most important and closely watched interest rates in the global financial system. It influences borrowing costs, savings yields, mortgage rates, business lending, credit cards’ annual percentage rate (APR) and even how crypto markets behave. 

What is the federal funds rate?

The federal funds rate is the interest rate at which US banks and credit unions lend money to one another overnight, using their reserve balances at the Federal Reserve. It’s the foundational benchmark for nearly all other interest rates in the US economy.

Importantly, the federal funds rate is not one single number. It is a target range – for example, 3.75% to 4% as set in late 2025. The actual market rate (the effective federal funds rate or EFFR) typically moves within that band.

Why banks lend ‘overnight’

Banks must hold a certain amount of reserves – cash or deposits at the Fed – to meet withdrawals and regulatory liquidity requirements. Because reserves fluctuate daily (deposits, withdrawals, loan disbursements and payments all happen constantly), banks usually end the day with too much or too little.

To stay in compliance:

• Banks with extra reserves lend to banks with shortfalls.
• Loans are overnight and unsecured.
• The interest charged becomes the ‘federal funds rate’.

Who decides the rate?

The Federal Open Market Committee (FOMC, the Fed’s policy-making arm) sets the target range. This group includes:

• Seven members of the Federal Reserve Board.
• Five rotating Reserve Bank presidents.
• The New York Fed president (permanent voter).

This committee meets eight times per year to set monetary policy.

Who sets the federal funds rate and how do they do it?

The federal funds rate is determined through policy decisions made by the FOMC, then maintained using tools that influence the supply and demand of reserves.

Step 1: Economic analysis

Before each meeting, teams of Fed economists prepare detailed reports covering GDP, employment, inflation, financial conditions, global risks and forecasts. These form the baseline for discussion.

Step 2: The FOMC meets and votes

During each meeting:

1. Economists present the outlook.
2. Members discuss risks.
3. Policy options are debated.
4. A formal vote sets the target range.

Decisions are announced in a press release at 2:00 PM Eastern Time (ET), followed by a press briefing from the Fed Chair.

Step 3: The Fed enforces the target range

The Fed doesn’t ‘fix’ the rate. Instead, it ensures market rates stay within the target band using a suite of administrative tools.

• IORB (Interest on Reserve Balances): The rate the Fed pays banks on reserves. It forms the upper boundary of the target range and discourages banks from lending below it.
• ON RRP (Overnight Reverse Repo Facility): Pays money market funds to lend to the Fed overnight, creating a floor under the rate for non-banks.
• Discount rate: The rate banks pay to borrow directly from the Fed, set above the target range and acting as a ceiling.
• Open market operations: The buying or selling of Treasuries to adjust reserve supply.

These tools keep the actual EFFR (e.g., 3.88% in November 2025) within the target.

What does the federal funds rate affect?

Though it targets interbank lending, the federal funds rate influences a wide range of financial products. The reason: it affects banks’ cost of money and that cost trickles through the entire financial system.

1. Prime rate

Banks use the prime rate (typically 3% above the federal funds rate) to price many loans, including credit cards, home equity line of credit (HELOC) and small business loans.

2. Mortgage rates

Mortgage rates are not directly tied to the federal funds rate. They move more closely with the 10-year Treasury yield, which reflects inflation expectations and long-term economic outlook. Still, Fed rate policy influences mortgage rates indirectly via market expectations.

• 30-year fixed mortgage rates averaged about 6.5% to 7% in late 2025.
• Adjustable-rate mortgages (ARM) and HELOCs move more directly with short-term rates.

3. Savings account yields

Banks raise or lower deposit yields in response to the federal funds rate.

• Traditional savings: About 0.40% to 0.60%
• High-yield online savings: About 4% to 4.5%

These fall when the Fed cuts rates.

4. Auto loans and personal loans

Auto loans react slowly, but personal loans track rates more closely.

• Auto loans: About 7% to 8%
• Personal loans: About 10% to 14% on average

 Rate cuts reduce borrowing costs over time .

5. Credit cards

Credit card APRs move quickly with the prime rate.

• Typical APR: 20% to 24%
• A 25 basis point Fed cut reduces yearly interest by only about $3 per $1,000 balance.

6. Financial markets

Lower rates can support risk assets (e.g., stocks), weaken the US dollar and support bond prices (lower yields), while higher rates may do the reverse, though real-world market reactions can differ depending on growth and risk sentiment.

Real vs nominal interest rate

Nominal refers to the stated rate, whereas real interest rate is the nominal rate minus inflation.

Real rates matter for long-term valuation and investor decisions.

As interest rates shift, so do market trends. Discover, buy or monitor top cryptocurrencies securely and easily on Crypto.com.

Why does the Fed raise or cut interest rates?

The Fed’s decisions stem from its dual mandate:

1. Maximum employment.
2. Price stability (2% inflation target).

To manage these goals, the Fed adjusts rates to guide economic activity.

Why the Fed raises rates

The Fed raises interest rates when the economy is expanding too quickly or when inflation threatens purchasing power. 

Higher rates make borrowing more expensive, which cools spending, slows down credit growth and reduces demand-side pressures that push prices upward. 

These are some of the top motivations for rate hikes:

• Fighting high inflation. When prices rise quickly, households lose purchasing power and businesses face volatile cost environments.
• Preventing the economy from overheating. In times of exceptionally strong growth, labor markets may see demand for workers outstripping supply. This drives wages sharply upward, which can feed back into price increases, forming a potential wage–price spiral.
• Cooling speculative excess. In financial markets, extended periods of low rates encourage borrowing, leverage and risk-taking. This can inflate bubbles in housing, equities, crypto and other assets.

Example: The 2022 to 2023 tightening cycle

After two years of near-zero rates during the COVID crisis, the US economy entered 2022 with accelerating wage growth, surging consumer demand, massive fiscal stimulus still circulating and supply chain disruptions that raised the cost of goods. 

Inflation became broad-based; it is not limited to food or energy, but visible across services, housing and durable goods, at as high as 9.1%.

The Fed responded by delivering four consecutive 75-basis-point hikes in mid-2022, which rapidly lifted the policy rate from near zero to restrictive territory. Subsequent smaller hikes eventually brought the target range to 5.25% to 5.5% by mid-2023, the highest in more than two decades.

Why the Fed cuts rates

The Fed cuts interest rates when the economy shows signs of slowing, when unemployment rises or when inflation falls below target. 

Lower rates make borrowing cheaper, stimulate spending, reduce debt burdens and encourage investment from households and businesses.

Primary motivations for rate cuts include:

• Supporting employment. When hiring slows or layoffs rise, reducing interest rates lowers the cost of credit for businesses, encouraging them to retain workers or expand operations.
• Reducing recession risks. In downturns, consumers reduce spending and businesses scale back investment. Lower rates help soften these contractions by improving access to affordable credit.
• Restoring financial stability. When markets freeze or credit tightens suddenly, the Fed may perform emergency cuts to restore confidence. Lowering the federal funds rate reduces funding pressures and signals that the Fed is ready to support the system with additional liquidity if needed.

Example: The COVID-19 emergency cuts 

In March 2020, the global economy shut down virtually overnight. With 22 million US jobs lost in two months and markets in freefall, the Fed performed:

• A 50 bp emergency cut on March 3.
• A 100 bp emergency cut on March 15.
• A rapid return to 0% to 0.25%.

These were the fastest cuts since the Great Recession and were paired with massive quantitative easing and emergency lending facilities to stabilize credit markets 

The 2024 to 2025 cutting cycle

Following the 2022 to 2023 inflation fight, the Fed held rates at a 23-year high through 2023. The first cut came in September 2024, followed by additional cuts in November and December 2024, and then in September and October 2025, bringing the target range down to 3.75% to 4%

This cycle shows a classic shift from inflation-fighting to economic support, guided by the Fed’s ‘data-dependent’ approach. When inflation moves closer to the 2% target but employment weakens, the Fed prioritises stabilizing the job market.

How is the federal funds rate determined?

The rate emerges from market mechanics shaped by supply and demand for bank reserves. Banks lend reserves to each other based on:

• Daily withdrawals
• Loan flows
• Payment settlements
• Seasonal effects (tax days, payroll cycles)

The effective federal funds rate (EFFR)

The New York Fed calculates the EFFR daily using the volume-weighted median of overnight trades among banks and certain financial institutions.

Key tools used in determination

When the FOMC sets a new target range for the federal funds rate, it relies on several operational tools to keep the effective federal funds rate (EFFR) within that band. 

• Open market operations (OMOs): The Fed buys or sells US Treasury securities to adjust the amount of reserves in the banking system and alter the federal funds rate upwards or downwards.
• Interest on reserve balances (IORB): The Fed pays interest to banks on the reserves they hold at the Fed Banks. Because banks will not lend reserves at a rate lower than what the Fed pays them risk-free, IORB helps create a soft upper boundary for the effective rate. It keeps the EFFR from falling too far below the top of the target range.
• Overnight Reverse Repurchase Facility (ON RRP): This tool allows money market funds and certain non-bank institutions to lend money to the Fed overnight in exchange for securities. The rate offered through the ON RRP facility forms a practical floor under the federal funds rate, as eligible institutions will not lend to banks at a lower return than the Fed itself offers.
• Discount rate: This is the interest rate banks pay when borrowing directly from the Fed’s ‘discount window’. Because the discount rate is set above the target range, banks will generally borrow from each other before using this facility. This effectively creates a ceiling on federal funds transactions.

Conceptual benchmark: The Taylor Rule

Economists refer to the Taylor Rule as a guideline for what the federal funds rate should be, based on inflation and economic conditions. 

It is not a rule the Fed must follow, but rather a framework that helps explain why interest rates rise or fall in response to macroeconomic pressures.

How the federal funds rate affects the average citizen

Even though the federal funds rate applies only to overnight lending between banks, its effects ripple into nearly every part of daily financial life. 

When the Fed adjusts rates, the cost of borrowing changes, savings yields shift and household budgets can feel the impact within weeks or months.

1. Loans: Mortgages, car loans, personal loans and more

While mortgages are influenced more by long-term Treasury yields, the federal funds rate still changes borrowing conditions across the board. 

When the Fed raises rates, monthly payments on new mortgages, auto loans and personal loans typically rise as lenders adjust their pricing. 

Conversely, when the Fed cuts rates, financing becomes more affordable, though mortgage relief arrives gradually and unevenly.

For people planning major purchases, rate cycles can meaningfully influence timing and affordability.

2. Credit cards: Fastest to react and hardest on households

Credit card APRs are tied directly to the prime rate, which moves almost immediately when the federal funds rate changes. 

This means rate hikes quickly make revolving balances more expensive. A 25-basis-point increase may sound small, but for households carrying debt at 20% to 24% APR, the compounding effect can strain budgets. 

Rate cuts help, but the relief can be modest, underscoring why paying down high-interest debt remains crucial regardless of Fed policy.

3. Savings and certificates of deposits (CD): How savers feel rate moves

When the Fed cuts rates, yields on traditional savings accounts drop quickly. High-yield online accounts respond more slowly but still trend downward over time. 

During cutting cycles, savers may benefit from locking in CDs before yields fall, while rate-hiking cycles reward those who keep cash flexible to capture rising returns. Understanding rate direction helps households choose between liquidity and yield.

4. Business financing: Costs that affect jobs, prices and growth

Small businesses may rely on credit lines and variable-rate loans tied to the federal funds rate. 

When rates rise, borrowing costs increase, squeezing margins and slowing expansion plans. 

When they fall, businesses generally find it easier to finance equipment, inventory and payroll. These dynamics influence not only entrepreneurs, but also employees, consumers and local economies.

5. Crypto: Liquidity-sensitive markets feel every rate change

Even though crypto operates outside traditional banking, it reacts sharply to changes in liquidity conditions. 

Higher federal funds rates tend to reduce risk appetite and cool speculative activity. Traders and investors may notice large pressures on Bitcoin and other altcoins. 

Lower rates, on the other hand, can fuel risk-on sentiment and attract capital into digital assets. 

For investors who follow both markets, the federal funds rate can help explain why crypto sometimes booms or stalls unexpectedly.

Learn more about crypto volatility and the causes.

History of the federal funds rate

Below is a simplified timeline of how the federal funds rate changed over the years.

Related terms and what they mean

Prime rate

The benchmark rate banks charge highly creditworthy borrowers, typically about 3% above the federal funds rate.

Discount rate

Rate charged by the Fed for banks borrowing directly from it. It forms the upper bound of market rates.

Real interest rate

Nominal interest rate minus inflation. It reflects actual purchasing power.

Yield curve

A chart showing interest rates across different maturities. Its shape signals economic expectations.

QE and QT

• Quantitative easing: The Fed buys bonds to add liquidity.
• Quantitative tightening: The Fed reduces holdings, removing liquidity.

As interest rates shift, so do market trends. Discover, buy or monitor top cryptocurrencies safely and easily on Crypto.com.

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Important information: This article is for informational and educational purposes only. It does not constitute financial or investment advice. All forecasting methods, scenarios, and examples are illustrative and subject to market uncertainty. It is essential to do research and due diligence to make the best possible judgment, as any purchases shall be your sole responsibility. Trading cryptocurrencies carries risks, such as price volatility and market risks. Before deciding to trade cryptocurrencies, consider your risk appetite. You can find more information on the risks involved with trading or holding crypto-assets here.

FAQs about the federal funds rate

What is the federal funds rate right now?

As of late 2025, the target range is 3.75% to 4%, with an effective rate of 3.88%.

What does it mean when the Fed raises interest rates?

It indicates the Fed is trying to cool the economy, reduce inflation, moderate spending and prevent asset bubbles.

Who decides interest rates in the US?

The FOMC, consisting of Fed Board members and regional bank presidents.

Why does the Fed raise rates during inflation?

Higher rates reduce borrowing and spending, which helps bring price growth back toward the 2% target.

How does the federal funds rate affect savings and borrowing?

Credit cards, HELOCs, ARMs and personal loans respond quickly. Mortgages respond indirectly. Savings yields decline after cuts.

When did the Fed start raising rates again?

In the 2022 tightening cycle, beginning in March 2022.

Is the federal funds rate the same as my credit card interest rate?

No, but credit cards track the prime rate, which moves with the federal funds rate.

What is the effective federal funds rate (EFFR)?

The actual market rate at which banks lend reserves overnight, calculated via the volume-weighted median by the New York Fed.

Why is the federal funds rate important?

It influences virtually all borrowing costs, shapes economic cycles, guides financial markets and determines liquidity across the economy.