Federal Reserve

The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States.

Interest rates

The Federal Reserve implements monetary policy largely by attempting to steer the federal funds rate, also called the overnight rate. The Federal Reserve roughly has the power to set the federal funds rate by fiat. In theory due to risk considerations, M0 injected by the Federal Reserve to lower money market rates need not find itself into the banking system. The money market rate/fed funds rate is the interest rate that banks charge each other for overnight loans to one another. This in turn influences the prime rate which is usually about 3 percentage points higher than the federal funds rate. This prime rate is the rate that most banks price their loans at for their best customers.

Related Topics:
Federal funds rate - Prime rate

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Lower interest rates stimulate economic activity by lowering the cost of borrowing, making it easier for consumers and businesses to buy and build. Higher interest rates slow the economy by increasing the cost of borrowing. (See monetary policy for a fuller explanation.)

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The Federal Reserve usually adjusts the federal funds rate by 0.25 or 0.50 percentage points at a time. From early 2001 to mid 2003 the Federal Reserve lowered its interest rates 13 times, from 6.25 to 1.00 percent, to fight recession. In November 2002, rates were cut to 1.75, and many interest rates went below the inflation rate. On June 25, 2003, the federal funds rate was lowered to 1.00 percent, its lowest nominal rate since July, 1958, when the overnight rate averaged 0.68 percent. Starting at the end of June, 2004, the Federal Reserve started to raise the target interest rate in response to concerns about the potential for increased inflation from a too-active economy. As of October 2005, the rate is at 3.75 percent; this is the result of a series of 10 .25 percent increases.

Related Topics:
2001 - 2003 - Recession - November - 2002 - Inflation - June 25 - 1958 - June - 2004

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The Federal Reserve has limited impact on longer-term interest rates. It can use open market operations to cause marginal changes in market yields, but its "buying power" on the market is significantly smaller than private institutions. The Fed can also attempt to "jawbone" the markets into moving towards the Fed's desired rates, but this is not always effective.

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