Explainer · Economy

How the Federal Reserve Sets Interest Rates

Last reviewed: September 26, 2026

Short answer: The Federal Reserve’s Federal Open Market Committee (FOMC) sets a target range for the federal funds rate, the interest rate for overnight borrowing by banks. It steers market rates into that range mainly by setting the interest rate it pays on banks’ reserve balances and the rate on its overnight reverse repurchase facility. Congress has told the Fed to pursue maximum employment and stable prices, and the FOMC defines price stability as 2 percent inflation over the longer run.

The mandate from Congress

The Constitution gives Congress the power “To coin Money, regulate the Value thereof.” Congress has delegated monetary policy to the Fed. Section 2A of the Federal Reserve Act directs the Board of Governors and the FOMC to promote “the goals of maximum employment, stable prices, and moderate long-term interest rates.” The Fed refers to the first two as its “dual mandate.”

The FOMC “judges that an inflation rate of 2 percent over the longer run, as measured by the annual change in the price index for personal consumption expenditures, is most consistent with the Fed’s price-stability mandate.”

Who decides

The FOMC has twelve members:

• the seven members of the Board of Governors in Washington;
• the president of the Federal Reserve Bank of New York; and
• four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis.

Nonvoting Reserve Bank presidents attend and take part in the discussion. Governors are nominated by the President and confirmed by the Senate for 14-year terms, staggered so that one term expires on January 31 of each even-numbered year. The Fed says that once appointed, governors “may not be removed from office for their policy views.”

How a rate decision works

The FOMC holds eight regularly scheduled meetings a year. When it wants to change the stance of policy, the Fed says, it primarily raises or lowers its target range for the federal funds rate:

• Easing: lowering the target range brings lower short-term market rates and looser financial conditions. It may be needed if the economy is sluggish or inflation is too low.
• Tightening: raising the target range raises interest rates and may be necessary if the economy is overheating or inflation is too high.

In the Fed’s words, it sets the stance of policy “to influence short-term interest rates and overall financial conditions with the aim of moving the economy toward maximum employment and stable prices.”

The tools behind the target

To keep short-term rates close to the target range, the Fed uses tools including interest on reserve balances (IORB), a rate set by the Board, and the overnight reverse repurchase facility rate. The FOMC’s implementation note after each decision lists the operational settings. The Fed also sometimes uses large-scale asset purchases, known as quantitative easing, and forward guidance about its future actions.

How the Fed answers to the public

The FOMC releases a written statement after every scheduled meeting, and the Chair holds a press conference after each meeting. The Federal Reserve Act also requires the Board to send Congress a semiannual Monetary Policy Report, delivered with testimony from the Chair.

Interest rates shape federal borrowing costs too; see debt ceiling vs. government shutdown. Prices also respond to trade policy; see how tariffs work.