Policy rate refers to the benchmark interest rate that a central bank uses to signal the stance of monetary policy. In the United States, the policy rate is the target for the federal funds rate (FFR) set by the Federal Reserve (the Fed). This rate influences the cost of money for banks and, through lending rates and financial-market expectations, can affect consumer and business borrowing costs, liquidity in the financial system, and inflation dynamics.
Central banks adjust the policy rate at regular policy meetings to communicate a policy stance. Raising the policy rate generally aims to curb inflation and cool demand, while lowering it seeks to support activity and price stability over time. The rate serves as a reference for other short-term interest rates and helps anchor expectations about future monetary conditions.
The policy rate is transmitted to the broader economy via banks’ loan and deposit rates, money-market rates, and exchange rates. Transmission can take weeks to months and depends on financial conditions, credit demand, and the overall economic environment. Policymakers may also employ related tools, such as open market operations or forward guidance, to achieve their objectives alongside the policy rate.
Policy-rate decisions are central to monetary policy and are guided by economic data on inflation, employment, growth, and financial stability. Market participants monitor policy-rate announcements for signals about the central bank’s outlook and potential future policy actions.
Example: Following a hotter-than-expected inflation report, the central bank raised the policy rate by 0.25 percentage point at its latest policy meeting.
Central bank · Federal Reserve · Federal funds rate · Monetary policy · Open market operations · Inflation targeting