What Makes The Federal Reserve Decide To Raise Or Lower Interest Rates?
What Makes The Federal Reserve Decide To Raise Or Lower Interest Rates?
Sep 28, 2026 Economic outlook Hilarey Gould Editorial staff, J.P. Morgan Wealth Management
As the United States’ central bank, the Federal Reserve (Fed) exists to promote the overall strength, stability and well-being of the U.S. economy.
As part of its monetary policy function, the Fed adjusts the federal funds rate to help meet its so-called dual mandate: controlling inflation and supporting maximum employment.
Interest rate hikes by the Fed aim to cool economic activity and inflation, while interest rate cuts aim to stimulate economic growth.
When the Federal Reserve decides to raise or lower the federal funds rate, it makes headlines – and for good reason. Even small rate adjustments affect the cost and availability of credit, sending ripples through the country’s larger economy. But why does the Federal Reserve cut or hike interest rates in the first place? Read on for a full breakdown, including how the federal funds rate functions as a powerful lever in the U.S. economy.
What is the Federal Reserve?
The Federal Reserve (Fed) is the central bank of the United States. Established in 1913 through the Federal Reserve Act, it comprises 12 Federal Reserve Banks, the Federal Reserve Board of Governors and the Federal Open Market Committee (FOMC). The three arms work together to carry out the following five functions:
Conducting the nation’s monetary policy
Supervising and regulating U.S.-based financial institutions
Promoting stability within U.S. financial systems
Fostering the safety and efficiency of financial transactions at all levels of the economy
Promoting community development and consumer protection Footnote 1 Opens overlay
With regard to the Fed’s most visible function – conducting monetary policy – Congress has tasked it with a dual mandate to maintain maximum employment and stable prices in the United States.
Current Fed Chair Kevin Warsh has been vocal about his commitment to fighting inflation and ensuring the central bank “delivers price stability.” Footnote 2 Opens overlay At the same time, Fed officials closely monitor the labor market every month to understand if it’s heating up or slowing down.
On the price stability front, the Fed’s goal is an annual inflation rate of 2%. Full employment, however, isn’t as easy to gauge. Instead of relying on a single figure to inform its decisions, the Fed considers a broad set of labor market indicators to determine what qualifies as maximum employment at any given moment.
Why does the Fed change interest rates?
One of the main tools the Fed uses to achieve its dual mandate is the federal funds rate – the interest rate banks charge each other for overnight loans of reserves. (Reserves refer to both the amount of cash a bank has physically on hand and its deposits with a central bank.)
When the Fed makes changes to this rate, financial institutions follow suit, which impacts the cost of all credit products (such as mortgages, car loans, personal loans, business loans, credit cards and more).
In turn, changes to the cost of credit products affect the spending behavior of U.S. households and businesses. Knowing this, the Fed adjusts the federal funds rate to steer economic activity as needed to achieve its goals.
What leads the Fed to raise interest rates?
The Fed raises interest rates when it needs to tighten monetary policy. One of the main reasons it does so is to combat high inflation.
For example, the Consumer Price Index (CPI) surged in 2022, hitting a 40-year high of 9.1% in June of that year – far above the Fed’s 2% inflation target. Footnote 3 Opens overlay
To stop and reverse the surge, the Fed implemented 11 rate hikes between 2022 and 2023, increasing the target range to 5.25%–5.50%. Footnote 4 Opens overlay
The rate hikes worked in bringing down inflation and the Fed lowered its federal funds rate. Then when stubborn inflation returned in 2026, the Fed increased the federal funds rate for the first time in three years at its September FOMC meeting. Footnote 5 Opens overlay
The FOMC also raises rates in response to factors that signal economic vitality, including a strong labor market, wage growth and expanding economic activity.
What leads the Fed to lower interest rates?
The Fed lowers interest rates when it needs to ease monetary policy – primarily to stimulate the economy and prevent or soften a recession. Among the key factors that can lead to cuts are rising unemployment, a weak labor market and subdued inflation.
In March 2020, for example, the FOMC dropped the federal funds rate to a target range of 0% to 0.25% in response to severe economic disruption brought on by the first U.S. wave of the COVID-19 pandemic.
The rate remained at 0% to 0.25% until rate hikes were needed to calm surging inflation in 2022. Footnote 6 Opens overlay After raising the rate and keeping it at a target range of 5.25% to 5.50% through 2024, the Fed lowered rates several times, with the last cut in December 2025 in response to positive economic signals. Footnote 7 Opens overlay
The Fed’s decision-making process when it comes to raising and lowering interest rates
The FOMC is the 12-member monetary policymaking arm of the Federal Reserve. It consists of the seven members of the Federal Reserve Board of Governors, the president of the Federal Reserve Bank of New York and four other Reserve Bank presidents (who serve one-year terms).
The group meets at least eight times a year to review economic and financial data and to decide on monetary policy actions. Its primary responsibilities include setting the target federal funds rate and directing open market operations, such as the buying and selling of U.S. government securities.
After each meeting, the FOMC releases a written statement outlining its decisions, including interest rate adjustments and the purchase or sale of securities to control the U.S. money supply. This statement is often accompanied by a press conference.
Key economic indicators the Fed monitors to make rate decisions
The Fed monitors a wide range of economic indicators to determine whether it will raise, lower or hold interest rates. Here are the most notable and how they’re tracked:
Inflation
What it measures: The rate at which the cost of goods and services is increasing
Reports tracked: The personal consumption expenditures (PCE) price index, consumer price indexes, producer price indexes and the Spot Commodity Price Index
Labor market data
What it measures: The supply of and demand for labor
Reports tracked: Nonfarm payroll employment, the unemployment rate, measures of labor utilization, the nonemployment index, labor market flows, labor force participation and more
Gross domestic product (GDP)
What it measures: The total output of goods and services in the economy
Reports tracked: Real GDP and its components
Consumer spending
What it measures: U.S. household spending
Reports tracked: Retail sales, consumer spending and income, auto sales, personal savings rates and housing market activity
Business investment
What it measures: U.S. business investments
Reports tracked: Investments in nonresidential structures, equipment, intellectual property, private construction and real nonresidential fixed investments
Trade
What it measures: International trade trends
Reports tracked: Balance of international trade and exchange value of the U.S. dollar
Manufacturing
What it measures: Manufacturing trends
Reports tracked: Industrial production, capacity utilization rates for manufacturing, core capital goods and more
Monetary policy and financial markets
What it measures: The financial system itself
Reports tracked: Fed system assets, monetary policy instruments, the federal funds rate, FOMC statements, money market rates, capital market rates, Treasury yield curve, fed funds futures and economic projections for the federal funds rate
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