What You Should Know About the Federal Funds Rate

Not everyone tracks the state of the economy, but when the news reports that it’s taking a nosedive, that usually gets people’s attention. There is one thing at the heart of our economy that can help you have a better understanding of how it all works, and that’s the federal funds rate. In this episode, I’m going to break down what the federal funds rate is. Who sets it? And most importantly, why should you, as someone managing your or your family’s finances, care about it? Episode Transcript

What is the Federal Funds Rate?

The federal funds rate is the interest rate that banks charge each other for overnight loans. Banks lend money to each other to meet their reserve requirements. Those reserve requirements are basically the amount of money they’re required to hold in their vaults so that they can meet their financial obligations in case there are a bunch of bank withdrawals. If you’d like to do a deep dive into the Bank Act of 1863 and the establishment of reserve requirements, I’ll put a link in the show notes for you.

Who Sets the Federal Funds Rate?

The federal funds rate isn’t just decided willy-nilly. It’s set by a group within the Federal Reserve, called the Federal Open Market Committee, or FOMC. The FOMC is the main decision-making body when it comes to the monetary policy for the U.S. economy. As a side, note, monetary policy just means the actions taken by the Federal Reserve to manage money and interest rates. Examples of actions would be lower interest rates or central banks buying government bonds. The FOMC meets eight times a year to mull over the state of the economy and decide what the federal funds rate should be. They look at what I’m sure is a boatload of data, like employment rates, inflation, and how the economy is growing, to figure out if the rate needs to go up, down, or stay the same. The FOMC decides on the rate during its meetings and usually announces any changes immediately afterward. By adjusting the federal funds rate, the FOMC can lower the cost of borrowing for businesses and consumers like us, which then affects the demand for goods and services. This can help regulate the growth of the economy and control inflation.

How Is the Federal Funds Rate Different from Regular Interest Rates?

You and I deal with interest rates, but they are different. The federal funds rate itself is mainly about the short-term lending that happens between banks. It’s not the rate you directly pay when you take out a loan, but it definitely impacts what rates you’ll see on loans and credit cards. The federal funds rate is the base or foundational rate that influences all other interest rates in the economy. The rate sets the tone for rates on our mortgage, car loans, and credit cards. When the federal funds rate goes up, the cost to borrow money goes up for everyone—banks, businesses, and us. When the federal funds rate goes down, borrowing money gets cheaper for everyone.

Why Should You Care?

You should care because the federal funds rate can affect your day-to-day life, especially when it comes to borrowing and saving money. Here’s how it impacts you.

Loans and Credit

When the Fed raises the federal funds rate, interest rates on things like mortgages, car loans, and credit cards usually go up. This means you’ll pay more in interest if you’re borrowing money. If the Fed lowers the rate, those interest rates might go down, making it cheaper to borrow.

Savings Accounts

The rate can also affect the interest you earn on savings accounts. Higher rates usually mean better returns on your savings, while lower rates mean your money won’t grow as quickly.

Inflation and Cost of Living

The Fed uses the federal funds rate as a tool to control inflation. If inflation is getting too high—meaning prices for goods and services are rising too quickly—the Fed might raise rates to cool or calm things down. This could lead to higher prices in the short term, but the goal is to prevent prices from getting out of control.

What Is the Current Federal Funds Rate?

You may now be wondering what the current federal funds rate is. As of this recording, the rate is 5.25%–5.50%. Fun fact—that’s the highest rate in 22 years.

Wrapping Up the Federal Funds Rate

Now for the wrap-up. Understanding the federal funds rate is key to making smarter financial decisions for you and your family. Whether you’re looking to buy a home, save for the future, or just manage your day-to-day expenses, knowing how this rate works—and how it impacts you—can give you an edge. Thank you to Navy Federal for providing support to the MILMO Show. You can also head over to milmo.co to get all of the resources and links from this episode, and while you’re there, be sure to sign up for the MILMO Memo newsletter to get all my updates. I appreciate you listening. I’ll talk to you next week. Related episode: What’s Your Trash Worth

Federal Funds Rate Resources

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