Federal Funds Rate

The FOMC does not set one number; it sets a target range, currently a 0.25-point band (for example 4.25%-4.50%). The rate that actually results is the effective federal funds rate (EFFR) — a volume-weighted median of the overnight transactions banks report each day, published every morning by the New York Fed. Because banks now hold ample reserves, the Fed keeps the EFFR inside the band with administered rates rather than reserve scarcity: the interest it pays banks on reserves (IORB) sets a floor, and the discount window — where a bank can borrow directly at a small penalty above the range — sets a ceiling.

Since the 2008 shift to ample reserves, very few banks actually need to borrow fed funds, so the market behind the policy rate is now thin. To price real-world contracts, markets increasingly rely on SOFR (the Secured Overnight Financing Rate) — a rate built from overnight Treasury repo transactions that replaced US-dollar LIBOR in 2023. The key difference: fed funds is unsecured interbank lending and serves as the Fed's policy target, while SOFR is secured (collateralized by Treasuries), reflects hundreds of billions of dollars of daily volume, and underlies most floating-rate loans and derivatives. The two normally track each other closely, but SOFR can spike when cash in the repo market is briefly scarce.

A change is usually quoted in basis points — one basis point is 0.01 percentage point, so a quarter-point move is 25 bps. The fastest channel to households is the prime rate, which US banks set by convention at the top of the fed funds target range plus 3.00 points. Credit cards, home-equity lines and many small-business and variable-rate auto loans are priced as prime plus a margin, so a Fed move reaches them within a billing cycle or two. A common misconception is that the Fed sets mortgage rates: 30-year fixed mortgages track the 10-year Treasury yield and expectations, not the overnight fed funds rate, which is why they can fall even as the Fed hikes.

The level of the rate alone does not reveal whether policy is loose or tight; that depends on two reference points. The first is inflation: the real fed funds rate is the nominal rate minus inflation, so 5% means very different things at 2% versus 8% inflation. The second is the neutral rate (economists write it r-star) — the rate that neither stimulates nor restrains the economy, estimated at roughly 2.5-3% in nominal terms. When the fed funds rate sits above neutral, policy is restrictive; below it, accommodative. This is why the Fed can be cutting and still be restrictive — what matters is the rate's distance from neutral, not its direction.