The following is a historic look at some of the highs and lows of the federal funds rate since the 1970s. Click on the year to find out the economic events that forced a rate change by the Fed.
The actual federal funds rate is the weighted average of interest rates that banks charge each other. It’s set by open market competition but comes remarkably close to the target set by the Fed.
The Federal Reserve, our nation’s central bank, has big weapons in its arsenal to keep the economy growing or to slow it down when inflation appears.
One of those weapons — arguably its most significant — is the federal funds rate, the interest rate banks charge each other for overnight loans. The Federal Open Market Committee sets a target for the rate. The actual federal funds rate is the weighted average of interest rates that banks charge each other, though it is usually close to the FOMC’s target rate.
“It’s a way of influencing how the economy works,” says Allan H. Meltzer, professor of political economy at Carnegie Mellon University and author of “A History of the Federal Reserve.”
Essentially, the Fed uses this interest rate on banks’ overnight loans as a lever on the economy. When the federal funds rate goes higher, banks are more reluctant to borrow from each other, and the trickle-down effect of higher interest rates on loans for individuals and businesses takes steam out of the economy.
On the other hand, a lower federal funds rate triggers more bank borrowing, which in turn greases the wheels for economic growth.
The details: The Fed gradually boosts the federal funds rate from late May to mid-July to 13 percent in an effort to curb inflation during a recession mainly triggered by soaring energy prices. The U.S. unemployment level hits 7.2 percent by the end of the year.
The details: A recession, at the time considered the worst since the Great Depression, grips the nation at the beginning of the year. Under Chairman Paul Volcker, the Fed is determined to quell inflation that has risen to more than 14 percent. It sets the federal funds rate in January at 14 percent, then boosts it as high as 20 percent two separate times during the year.
The details: With the economy still struggling from the second recession in three years and continued double-digit inflation, the Fed raises the federal funds rate in late May to 20 percent. Public opinion polls show widespread disapproval with President Ronald Reagan’s handling of the economy, and Democrats gain 26 U.S. House seats in midterm elections the following year.
The details: After a rough start to the early 1980s, the U.S. economy finally expands again as unemployment levels off and inflation subsides. With continued moderation in inflation, the Fed lowers the federal funds rate to 8.75 percent in early December to help the economy grow.
The details: After a recession started the decade, the nation stands poised for economic prosperity. The Fed propels growth by starting the year with a federal funds rate of 3 percent, one of the lowest marks in years, and the rate hovers around 3 percent for much of the year. This greases the housing market with lower mortgage rates and helps businesses expand and add jobs. Meltzer says President Bill Clinton’s long-term debt-reduction plan “gave people confidence to invest.”
The details: Following two years when 2 million people lose their jobs, the manufacturing, construction and technology sectors are leading an economic recovery. The Fed cuts the federal funds rate to 1 percent in June, and growth accelerates during the second half of the year at the fastest pace in nearly two decades.
The details: The housing market’s troubles prove to be far worse than expected, as spending on housing projects for the year tumbles by the largest margin in 25 years. However, energy prices are high and the Fed has inflationary concerns. But, with the economy slowing, it begins to lower the federal funds rate to 4.75 percent and eventually to 4.25 percent.
Rate: Decreases to a range of zero percent to 0.25 percent
The details: The country is gripped by financial crisis as the housing bubble bursts, the investment bank Lehman Brothers fails in September, and the stock market takes a nose dive. During the year, people lose their jobs in droves, credit dries up for small businesses and consumer confidence crumbles. President Barack Obama is elected in November; he will face a full-blown recession when he takes office in 2009.
The Fed responds aggressively to the financial turmoil by lowering the federal funds rate, desperately trying to stimulate the economy. It pushes the federal funds rate in December to its lowest level in more than 50 years.
Rate: Remains in a range of zero percent to 0.25 percent
The details: There are still more Americans out of work in the U.S. than when the recession began, although the unemployment rate drops to a five-year low of 7 percent. Consumer confidence is on the rise in December as the year ends.
The Fed announces it will begin to taper its stimulus program, cutting monthly asset purchases from $85 billion to $75 billion. It says it will likely keep the low federal funds rate “well past the time” the unemployment rate drops below 6.5 percent.
“The Fed has recognized that the economy is no longer a basket case,” said Joel Naroff, president of Naroff Economic Advisors. “But they’re not ready to commit to cutting all the strings. That’s why they’re tapering.”