How the Federal Reserve actually sets interest rates

The Federal Open Market Committee meets on a published schedule and announces a target range for the federal funds rate — the rate at which depository institutions lend reserve balances to one another overnight. The committee cannot order banks to transact at that rate. It creates conditions in which they will.

The tools that do the steering

• Interest on reserve balances (IORB): what the Fed pays banks on reserves held at the Fed, setting a floor beneath which a bank has little reason to lend.
• The overnight reverse repurchase agreement facility (ON RRP): available to a wider set of counterparties, including money market funds, reinforcing that floor.
• The discount window: a ceiling-style backstop for banks borrowing directly from the Fed.
• The size and composition of the Fed's securities holdings, which influence longer-dated yields.

Together these administered rates keep the effective federal funds rate — a volume-weighted median of actual overnight transactions, published each business day — inside the target range.

The mandate behind the decision

Congress directs the Federal Reserve to pursue maximum employment and stable prices. The committee weighs incoming data on inflation, labour market conditions and financial stability, and communicates its expectations through the post-meeting statement, the chair's press conference and the Summary of Economic Projections.

How it reaches your bank account

Policy rates transmit unevenly. Rates tied closely to overnight funding — credit card variable rates, some business loans, savings account yields — move relatively quickly. Long-dated fixed borrowing such as a 30-year mortgage tracks longer-term yields, which reflect expectations for growth and inflation over years, not the current overnight rate. That is why mortgage rates can fall while the policy rate rises, and vice versa.

Other central banks, same logic

The European Central Bank sets its deposit facility rate as the primary policy instrument, and the Bank of England sets Bank Rate. The institutional details differ, but the mechanism is comparable: an administered rate anchors the shortest end of the curve, and everything else is priced relative to expectations for it.