federal reserve

8 ways the Federal Reserve's interest rate decisions affect your life

Inside the Fed's toolbox
Inside the Fed's toolbox | Fraser Hall/Getty Images

Inside the Fed's toolbox

The Fed has 3 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.

  • Through "open market operations," it buys Treasury securities 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 that 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 give loans more freely.

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