Interest rates and the Fed, explained
The price of borrowing money, who sets it, and why a change in Washington shows up in your car loan and savings account.
An interest rate is the price of borrowing money. If you borrow $1,000 at 10% a year, you pay about $100 a year for the use of it. When you're the one saving, interest works for you: the bank pays you for keeping your money there.
The Federal Reserve, or "the Fed," is the United States' central bank. Eight times a year it sets a target for the rate banks charge each other for overnight loans. That one rate ripples out to almost every other rate: credit cards, car loans, mortgages and savings accounts.
The Fed has two jobs: keep prices stable (inflation around 2%) and keep as many people working as possible. When inflation runs high, the Fed raises rates. Borrowing gets more expensive, so people and businesses spend less, and prices cool off. When the economy is weak and people are losing jobs, the Fed cuts rates to make borrowing cheaper and get spending going again.
There are other rates in the news too. A Treasury yield is what the U.S. government pays to borrow from investors. The 10-year Treasury yield is set by investors buying and selling, not by the Fed, and it heavily influences mortgage rates.
Why it matters to you: a few percentage points can add up to thousands of dollars. A higher rate makes a car loan cost more each month. It also means a high-yield savings account pays you more. So the same Fed decision can hurt borrowers and help savers.
For teachers: covers NC EPF EPF.E.2.3 Fiscal and monetary policy: jobs, interest rates and prices; EPF.E.2.4 Economic institutions and their roles; EPF.MCM.2.2 How interest and fees affect spending, debt and savings.
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Lesson worksheets
Words to know
- Interest rate
- Interest shown as a percent of the amount borrowed or saved, usually per year.
- Federal Reserve
- The U.S. central bank, often called the Fed. It raises or lowers a key interest rate to keep prices stable and jobs plentiful.
- Yield
- The yearly return an investment pays, shown as a percent. For bonds, yields go up when prices go down.
- Treasury
- A loan you make to the U.S. government. Treasuries are considered one of the safest investments.
- Bond
- A loan you make to a government or company. It pays you interest and returns your money on a set date.
- APR
- Annual percentage rate: the yearly cost of borrowing money, shown as a percent. It includes interest and some fees. Many credit cards charge more than 20%.
- Inflation
- When prices rise across the economy, so each dollar buys a little less.
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More topics
Inflation · The stock market · Investing · Budgeting · Paychecks and taxes · Credit cards and credit scores · Loans and debt · Banking and saving · Insurance · Scams and identity theft · The economy: jobs, GDP and recessions · Supply and demand · Tariffs and trade
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