Skip to content

How Does the Federal Funds Rate Affect Consumers?

Wednesday, January 10, 2018

By Laura Hopper, Public Affairs Staff

The fed funds rate creates ripple effects on consumer interest rates | St. Louis Fed

One of the roles most commonly associated with the Federal Reserve is setting interest rates. But which rates does the Fed really control, and how does that affect you as a consumer?

The Fed Funds Rate

It starts with what’s known as the federal funds rate—the rate that banks charge each other for short-term loans.

The Federal Open Market Committee (FOMC) sets a target for the funds rate; ordinarily, the market-determined funds rate tracks closely the committee's target. The FOMC is the monetary policymaking body of the Federal Reserve and typically meets eight times a year.

How does the federal funds rate affect others, such as interest on savings accounts, mortgage rates or car loan rates? It’s like throwing a pebble on a pond. It creates ripple effects that diminish farther away from the center.

Close to the Center

Short-term rates are closely tied to the federal funds rate. These include:

  • Rates on short-term Treasury bills and securities
  • Private short-term money market rate

You can picture them near the center of the pebble’s ripples, says David Wheelock, St. Louis Fed vice president and deputy director of research.

Ripples Farther Out

Rippling farther out from the pebble are rates more familiar to consumers in their everyday lives. These may include:

  • Credit cards
  • Home equity lines of credit
  • Adjustable-rate mortgages
  • Auto loans

Interest rates for fixed-rate 30-year mortgages are among the furthest out, as are longer-term Treasury securities.

"If the federal funds rate is falling, then in some sense, the cost of funds for the bank is falling," Wheelock says. "So, they’re able to pass along that to their borrowers in the form of lower interest rates on their car loans or their mortgage loans and so forth."

Meanwhile, if the federal funds rate is rising, the opposite can be true.

Watching the Waves

As the ripples spread further from the pebble, the FOMC's job is also to make sure the waves don’t carry rates too far in the other direction.

For instance, Wheelock says, continued reductions to interest rates might reflect a monetary policy that’s "too loose." In that scenario, "if you overdo it, then you're getting too much money out in the economy and you get inflation," Wheelock says. "And then inflation actually works in the opposite way by forcing interest rates up.

“So, there’s a happy medium.”

Additional Resources:

Laura J. Hopper 

Laura Hopper is the St. Louis Fed's employee ambassador coordinator. She works in Public Affairs.

Tagged laura hopperdavid wheelockfederal reservefed funds ratefederal funds rateFOMCinterest ratesmonetary policymortgage ratesinflation
Commenting Policy: We encourage comments and discussions on our posts, even those that disagree with conclusions, if they are done in a respectful and courteous manner. All comments posted to our blog go through a moderator, so they won't appear immediately after being submitted. We reserve the right to remove or not publish inappropriate comments. This includes, but is not limited to, comments that are:
  • Vulgar, obscene, profane or otherwise disrespectful or discourteous
  • For commercial use, including spam
  • Threatening, harassing or constituting personal attacks
  • Violating copyright or otherwise infringing on third-party rights
  • Off-topic or significantly political
The St. Louis Fed will only respond to comments if we are clarifying a point. Comments are limited to 1,500 characters, so please edit your thinking before posting. While you will retain all of your ownership rights in any comment you submit, posting comments means you grant the St. Louis Fed the royalty-free right, in perpetuity, to use, reproduce, distribute, alter and/or display them, and the St. Louis Fed will be free to use any ideas, concepts, artwork, inventions, developments, suggestions or techniques embodied in your comments for any purpose whatsoever, with or without attribution, and without compensation to you. You will also waive all moral rights you may have in any comment you submit.
comments powered by Disqus

The St. Louis Fed uses Disqus software for the comment functionality on this blog. You can read the Disqus privacy policy. Disqus uses cookies and third party cookies. To learn more about these cookies and how to disable them, please see this article.