What Does the Federal Reserve Do?

Among other functions, the Fed supervises and regulates financial institutions, conducts national monetary policy, and sets the target interbank interest rate (called the “federal funds rate”).

Changes in the federal funds rate determine what banks charge to borrow money from each other. What a bank pays to borrow from another institution affects what it charges a consumer to borrow from the bank. So when the Fed changes the target federal funds rate, your everyday bills and finances can be affected. 

Read on to learn more about the Fed, its role in the economy, and how changes in the federal funds rate can impact the cost of living and more.

What is the Federal Reserve System and why was it created?

Congress passed the Federal Reserve Act in 1913 to support a safer and more stable economy after several banking crises. The Federal Reserve System was formed in 1913 as an independent body to protect the nation from these recurring crises.

The Federal Reserve Act sets out three primary goals for the Federal Reserve System: maximum employment, stable prices, and moderate long-term interest rates.

The Federal Reserve System is made up of three main elements: the Board of Governors, 12 reserve banks, and the Federal Open Market Committee (FOMC), which consists of members of the Board of Governors and Reserve Bank presidents. This committee is the body that sets the target federal funds rate.  

What is the purpose of the Federal Reserve?

The Federal Reserve is responsible for five key functions. First, the Fed conducts national monetary policy with the goals of maximum employment and stable prices. Monetary policy refers to the tools and strategies that a nation’s central bank uses to promote economic growth and support a stable economy. The Fed sets monetary policy for the United States.

The Fed is also responsible for promoting the stability of the financial system, promoting the safety and soundness of financial institutions, promoting consumer protection and community development, and fostering safe and efficient payment and settlement systems.

What happens at the Federal Open Market Committee meetings?

The FOMC meets eight times each calendar year. During these meetings, the committee reviews economic and financial conditions. They then make monetary policy decisions, such as adjusting the target federal funds rate.

After each meeting, the FOMC releases a statement to summarize the Committee’s policy decision and the economic outlook. In addition, the Chairman of the Fed, currently Jerome Powell, gives a briefing to the press to discuss these issues and an assessment of the economy.

What is the impact of FOMC meetings?

When the FOMC decides to change the federal funds rate, other rates may be affected—including short-term interest rates, foreign exchange rates, and long-term interest rates. Eventually, other economic indicators can be affected, too, such as the prices of consumer goods and services. Because these have an impact on company finances, employment levels may also be affected.

Why is the FOMC concerned about inflation?

Inflation rates are one of the key concerns of the FOMC. High inflation rates result in higher prices for essential products and services, such as food, energy, and housing. Lowering inflation is one of the main reasons why the FOMC raises the federal funds rate.

What is the federal funds rate?

The federal funds rate is the rate at which banks in the U.S. lend to each other. When the news reports that the Fed has raised or lowered interest rates, they are talking about the federal funds rate.

Why does the Federal Reserve adjust the federal funds rate?

Raising and lowering the federal funds rate can help regulate the nation's employment levels. It also stabilizes prices because changing the federal funds rate can lead to changes in interest rates that affect consumers.

For instance, when the Fed raises the federal funds rate, one goal is to make it more expensive to borrow money, which means people will likely decrease spending on goods and services. As a result, less money is exchanged between consumers and businesses. The economy slows down, and because there is lower consumer demand, the price of goods and services should decrease.

How has the federal funds rate changed in recent years?

Over the past few years, the Fed has made multiple adjustments to the federal funds rate, which has affected the overall economy and the financial situation of consumers.

After the pandemic led to a global recession in 2020, the Fed lowered the federal funds rate to 0%.¹ This boosted the economy because people could borrow more cheaply, helping them buy more expensive items, including cars and houses.

Then, these low rates, combined with government stimulus money sent to American households, increased demand dramatically. This caused a jump in consumer prices. Worried about inflation, the Fed raised the federal funds rate seven times in 2022 to slow the economy. In the same way that lowering interest rates may result in more consumer spending, raising the interest rate might reduce spending.

The Fed continued to raise the federal funds rate until July 2023, when it set the target range to between 5.25% and 5.5%.³  

How does the Federal Reserve affect your money?

The Fed’s monetary policy actions are intended to keep inflation at about 2%. At the same time, the Fed also tries to balance the economy’s health to keep employment high. But the Fed’s actions can also affect your personal finances in other ways.

When the Fed raises the target federal funds rate, it becomes more expensive for banks to borrow money. As a result, banks typically raise the interest they charge to consumers, which can lead to a decrease in consumer lending. In other words, it may be harder to get a loan or credit card. Or the interest rates on credit cards and loans might be less advantageous.

Does the Federal Reserve regulate cryptocurrency?

In recent years cryptocurrency has become a much-debated topic. This form of digital money is managed by computer networks and not backed by any government. Since the Fed regulates banks and the U.S. dollar, cryptocurrencies are not fully regulated. But as the Fed pushes for stricter oversight, its authority over cryptocurrency may eventually increase. 

How do interest rate changes impact loans and credit?

Monetary policy and interest rate fluctuations can eventually affect mortgages, car loans, lines of credit, and credit card interest rates. For example, when rates rise, payments on variable rate bills like credit cards could increase. This is one reason why consolidating higher-interest, variable rate debt with a lower-interest, fixed-rate loan may be a good idea when you plan your long range budget.

How do interest rate changes impact savings?

During periods where interest rates are higher, consumers may earn more money by placing money into savings accounts. Consumers can choose different savings account options, such as high-yield savings accounts that can earn more interest than regular savings accounts.

What should you do when the Federal Reserve meets?

You don’t have to track the Fed’s every action. But because the cost of borrowing is affected by the federal funds rate, it could be helpful to keep tabs on the federal funds rate if you’re planning to make a major financial decision. The cost of loan you take out, say, to buy a house or make home improvements, could be impacted.

It’s important to look at all the details of any type of loan you’re considering, not just the interest rate. Some lenders may charge additional fees, such as lender fees or prepayment penalties, that can change the total cost of your loan. Lenders must tell you all the costs and fees that factor into the annual percentage rate (APR). To make sure you know the impact that both interest rates and APR can have on your wallet, it’s a good idea to review both when you are comparing loans.

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The information provided herein is for informational purposes only and is not intended to be construed as professional advice. Nothing contained in this article shall give rise to, or be construed to give rise to, any obligation or liability whatsoever on the part of Discover Bank or its affiliates.

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For more detailed information, visit https://www.federalreserve.gov/monetarypolicy/fomc.htm