WASHINGTON, July 8 — The Federal Open Market Committee’s target range for the federal funds rate stands as the central lever of American monetary policy, a fact underscored by the record of the past several years. The federal funds rate is the interest rate at which depository institutions — banks and credit unions — lend reserve balances to one another overnight. It is, according to the Federal Reserve’s own framework, the primary tool the central bank uses to influence monetary policy.
The FOMC sets a target range for this rate, and the mechanism is implemented through open market operations — the buying and selling of Treasury securities — and through the interest on reserve balances rate, known as IORB. The record shows that as of mid-2024, the target range stood at 5.25 percent to 5.50 percent.
That level represented the culmination of a rapid tightening cycle that began in early 2022. The timeline is instructive: when the Federal Reserve began raising rates, the average 30-year fixed mortgage rate sat at about 3 percent. By late 2023, that same average had risen to over 7 percent.
The transmission mechanism was direct and documented. Changes to the federal funds rate do not operate in isolation.
They affect other short-term interest rates across the financial system. The prime rate, for example, is typically 3 percentage points above the federal funds rate. The Secured Overnight Financing Rate, or SOFR, and Treasury bill yields also move in response.
The ripple through consumer credit
The record shows that credit card APRs, which are often tied to the prime rate, increased from about 16 percent to over 21 percent during the same period the Fed raised rates. Auto loan rates and both 30-year and 15-year fixed mortgage rates felt the same pressure. The transmission mechanism influences these longer-term rates through the chain of short-term rate adjustments.
On the savings side, the federal funds rate also affects the yield on savings accounts and certificates of deposit, known as CDs. The effective federal funds rate itself is calculated as a volume-weighted median of overnight transactions.
That technical detail matters because it is the actual rate at which reserves trade, distinct from the FOMC’s stated target range.
The mechanism behind the rate
The Federal Reserve implements the rate through two primary channels. Open market operations involve the buying and selling of Treasury securities, which influences the supply of reserve balances in the banking system. The interest on reserve balances rate, or IORB, provides a floor for the federal funds rate by giving banks an alternative return for holding reserves at the central bank.
The IORB is a key tool for keeping the effective federal funds rate within the FOMC’s target range. The record shows that the federal funds rate is the primary tool the Federal Reserve uses to influence monetary policy.
Its adjustments flow through the financial system, affecting borrowing costs for households, businesses, and governments alike. Looking ahead, the path of the federal funds rate remains the subject of close scrutiny. The timeline of the past two years — from near-zero rates to the current target range — provides the framework for understanding what comes next.
