The policy rate is the benchmark interest rate a central bank sets to influence borrowing and lending costs across the entire economy. In the United States, the policy rate is the federal funds rate, which the Federal Reserve targets within a range currently set at 3.50% to 3.75% as of early 2026.1Federal Reserve Board. The Fed Explained – FOMC Target Federal Funds Rate When the Fed moves that target up or down, the change flows through credit cards, mortgages, business loans, and savings accounts, changing what you pay to borrow and what banks pay you to deposit.
Who Sets the Rate and When
The Federal Open Market Committee is the body that decides the target range. Federal law requires at least four meetings a year, but in practice the FOMC meets eight times annually on a published calendar.2Federal Reserve Board. Meeting Calendars and Information Each meeting ends with a statement announcing whether the target range is being raised, lowered, or left alone, followed by a press conference from the Fed Chair explaining the decision.3Federal Reserve Board. Speech by Vice Chair Jefferson on Central Bank Communication
How the Fed Holds the Rate Where It Says
The federal funds rate itself is the interest banks charge one another for overnight, uncollateralized loans — the money they move between each other to settle the day’s obligations.4Federal Reserve Bank of New York. Effective Federal Funds Rate The FOMC does not set the price on any individual loan. It announces a target range and then uses two tools to steer the actual market rate into that range.5Federal Reserve Board. Economy at a Glance – Policy Rate
The main tool is the interest the Fed pays banks on the reserve balances they keep at their regional Federal Reserve Bank. That rate sat at 3.65% as of January 2026 and acts as a floor, because a bank has little reason to lend overnight to another bank for less than the Fed will pay it to hold the money.6Federal Reserve Board. Discount Rate Meeting Minutes, January 2026 At the top of the range, the discount rate — what the Fed charges banks that borrow from its discount window — works as a ceiling, since banks would rather borrow from each other for less than pay the Fed’s higher price.
A note on something you may have heard about: banks are no longer required to hold specific reserve amounts at the Fed. The Federal Reserve dropped all reserve requirement ratios to zero percent effective March 26, 2020, and they remain there.7Federal Register. Reserve Requirements of Depository Institutions The current approach, called an “ample reserves” framework, steers the federal funds rate through the interest paid on reserves rather than by controlling how much banks must keep on hand.
What the Fed Is Trying to Do When It Moves the Rate
Federal law tells the Fed what to aim for. Under 12 U.S.C. § 225a, the committee must promote “maximum employment, stable prices, and moderate long-term interest rates.”8Office of the Law Revision Counsel. 12 U.S. Code 225a – Maintenance of Long Run Growth of Monetary and Credit Aggregates This is commonly called the “dual mandate” because the Fed treats stable prices and maximum employment as the two primary objectives.9Federal Reserve Board. Monetary Policy: What Are Its Goals? How Does It Work?
For prices, the Fed’s official 2% inflation target is measured against the Personal Consumption Expenditures price index, not the more familiar Consumer Price Index. The Fed prefers PCE because it adapts more quickly to shifts in how Americans actually spend.10Federal Reserve Board. Inflation (PCE) CPI, published monthly by the Bureau of Labor Statistics, still factors into the broader discussion.11U.S. Bureau of Labor Statistics. Consumer Price Index Frequently Asked Questions For employment, the committee reviews data including the unemployment rate and monthly payroll figures.
The logic running under rate decisions is simple. When job growth slows or unemployment rises, the Fed may cut rates to make borrowing cheaper and encourage hiring. When the economy runs hot and prices climb too fast, the committee raises rates to cool spending and push inflation back toward 2%.
How a Rate Change Hits Your Borrowing
The most immediate consumer channel is the prime rate. Most commercial banks set their prime rate at roughly three percentage points above the top of the federal funds target, placing it near 6.75% in early 2026. Prime is the reference point for pricing a long list of consumer and business loans.
Credit cards react fastest. Most card interest rates are variable, calculated by adding a fixed margin to the prime rate, so when the Fed raises its target, your card rate typically rises by the same amount. Issuers are not required to send you 45 days’ advance notice before that kind of increase. The standard 45-day notice rule under federal credit card regulations does not apply when the rate change comes from a change in an index like prime.12Federal Reserve Board. New Credit Card Rules
Mortgages split in two directions. Adjustable-rate mortgages move with benchmark rates, though the adjustment timing depends on the loan terms, commonly once a year after the initial fixed period. If you are in the middle of buying a home, a rate lock can protect you from increases during the closing period, and locks are typically available for 30, 45, or 60 days.13Consumer Financial Protection Bureau. What’s a Lock-In or a Rate Lock on a Mortgage? If you already have a fixed-rate mortgage, policy rate changes do not touch it until you refinance or take out a new loan.
Small business borrowers feel it through SBA 7(a) loans, which cap interest at prime plus a margin that depends on loan size:14U.S. Small Business Administration. Terms, Conditions, and Eligibility
- $50,000 or less: prime plus up to 6.5%
- $50,001 to $250,000: prime plus up to 6.0%
- $250,001 to $350,000: prime plus up to 4.5%
- Over $350,000: prime plus up to 3.0%
Because these caps sit on top of prime, every quarter-point move by the Fed raises or lowers the ceiling on what SBA lenders can charge.
How a Rate Change Hits Your Savings
The policy rate also pulls on what banks pay you to keep money with them. When the federal funds rate is higher, banks earn more on their own overnight lending and have room to offer higher yields on savings accounts, money market accounts, and certificates of deposit. When the Fed cuts, deposit yields usually drift down with it.5Federal Reserve Board. Economy at a Glance – Policy Rate
The pass-through is not even. Banks set deposit rates based on their own competitive pressures and funding needs, so some move faster or further than others. With the federal funds target at 3.50% to 3.75% in early 2026, top CD rates ran from roughly 3.50% to just above 4.00% APY depending on the term and institution. When the policy rate peaked at 5.25% to 5.50% in 2023 and 2024, the best CD yields were noticeably higher.
A high nominal yield does not automatically mean your money is growing. The real interest rate — your yield minus the inflation rate — is what tells you whether your purchasing power is actually rising. A CD paying 4.0% while inflation runs at 3.0% gives you about a 1.0% real return. In periods when inflation outruns deposit rates, savings lose ground even as they earn interest.