The Fed has three ways of influencing the federal funds rate, which is the rate at which banks lend to each other overnight and is used as the benchmark for a range of consumer interest rates.
- It buys Treasury securities from the market to shrink the supply of government debt, thereby increasing the price and bringing down the interest rate on the securities. (Or, it sells Treasuries into the market to increase the supply, lower the price and raise interest rates.)
- It sets the discount rate, which is the rate at which banks may borrow from regional Federal Reserve Banks. If the discount rate is raised, banks bear higher borrowing costs and tend to curb their lending, boosting interest rates. If it's lowered, banks generally make credit more widely available and rates fall.
- It establishes reserve requirements, or the amount of capital banks must hold as security for the deposits on their books. If reserve requirements are increased, banks tend to reduce their lending activity; if they're loosened, banks make loans more freely.