The fed interest rate is part of the plan by which the Federal Reserve is supposed to maintain what is termed “full employment”, or more accepted as four to five percent unemployment. It should also work to keep inflation low. This is a difficult feat to accomplish, and today, the fed interest rate has been brought down to artificial lows, in an effort to cause growth in the economy.

Bringing down the federal interest rate is their most powerful means of influencing the economy. When the interest rates are set low, you can acquire capital more easily. This can often help to create growth, because if you have more cash that is available to you, you'll be more likely to spend it on something you have decided you want. If the fed interest rate is left too low for too long, businesses will realize that there is more money, and they will adjust their prices upward. This is inflation at its most basic, and pretty soon it will cost you more for everything you purchase.

On the other side of the coin, if the fed interest rate is too high, this can lead to recession, and eventually deflation. This can severely hinder the economy, since everything will cost you more in purchasing power than it did before.

The Federal Reserve influences interest rates in two ways, either by lowering or raising the discount rate, or by influencing indirectly the Federal funds rate direction.

When the Federal Reserve manipulates the discount rate, this directly affects the price that banks pay when they borrow from the Federal Reserve Banks. If your bank pays a higher rate of interest, they will pass that on to you when you borrow from them. This will result in less money borrowed, because it costs more to do so. The amount of spending will decrease, which makes prices remain more stable.

The Federal funds rate is defined as the rate that individual banks will charge each other for overnight loans. The Fed may require that banks keep a percentage of their assets on hand or in deposit at a Federal Reserve bank. When they raise the ratio required of reserves to deposits is increased, the banks must keep more cash in the vault each night, and when this happens, funds will be more expensive to acquire. When they lower the reserve requirements, the supply of money is looser, since less cash needs to be kept, and capital is more easily acquired.