"Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In support of these goals, the Committee decided to maintain the target range for the federal funds rate at 2-1/4 to 2-1/2 percent."
—FOMC Statement, March 20, 2019
The Federal Reserve is the central bank of the United States. Its dual mandate from Congress is to promote maximum employment and price stability. To achieve this mandate, the Federal Reserve conducts monetary policy by influencing market interest rates. However, the means by which the Federal Reserve influences interest rates have changed over time.
Influencing the Economy through the Federal Funds Rate
For decades prior to 2008, the Federal Reserve's Federal Open Market Committee (FOMC) would adjust monetary policy to match economic conditions by raising or lowering its target for the federal funds rate (FFR), the rate that banks charge each other for overnight loans.2 The Fed can influence the general cost of borrowing through this one rate because, although short-term interest rates differ from each other, they are closely linked.3 If one short-term rate gets much below others, financial institutions will tend to borrow in that market and lend where rates are higher. This tendency puts upward pressure on the lower rate and downward pressure on the higher rate—keeping rates linked. This is known as arbitrage, an important aspect of the way financial markets, and monetary policy, work. So, by influencing one rate—the FFR—the Federal Reserve can influence other short-term rates, which affect longer-term interest rates, consumer and producer decisions, and ultimately the level of employment and inflation in the U.S. economy (Figure 1).