How does the Federal Reserve influence interest rates?

The Federal Reserve influences interest rates primarily by setting the federal funds rate and conducting open market operations. The federal funds rate is the interest rate at which banks lend reserves to each other overnight. By adjusting this rate, the Federal Reserve can make borrowing more or less expensive. For example, a lower federal funds rate encourages banks to lend more, which can stimulate economic activity and increase investment, while a higher rate typically has the opposite effect.

Open market operations involve the buying and selling of government securities in the market by the Federal Reserve. When the Fed purchases securities, it injects liquidity into the banking system, which can lead to lower interest rates. Conversely, selling securities can withdraw liquidity, leading to higher interest rates. Together, these tools allow the Federal Reserve to effectively steer the economy in response to inflation, employment levels, and overall economic growth.