Why Does the Fed Raise or Lower Interest Rates?

When the Federal Open Market Committee (FOMC, or the “Fed”) meets to weigh changing the federal funds rate, as it does eight times each year, the resulting decision invariably makes headlines. That’s because the federal funds rate (or the rate at which banks loan money to one another) can have big implications for financial markets and individual consumers. Whether the federal funds rate goes up, down, or stays the same, these choices can impact the cost of borrowing money and the amount you earn on your savings. But why does the Fed decide to raise or lower interest rates?

In this post, I’ll break down what you need to know. 

It’s about the dual mandate

The most important thing to know about the Fed is that they have a “dual mandate” to keep prices stable and encourage maximum employment. These are the Fed’s two main objectives, meaning they work hard to ensure that the country avoids both high inflation and high unemployment—both of which can put significant strain on Americans.

Mary C. Daly, president and CEO of the Federal Reserve Bank of San Francisco described growing up during a period of high inflation in the 1970s in a speech at Boise State University in 2022. She explained the challenges high prices posed, even for those who were employed. “The enduring lesson of my childhood is that people need both jobs and stable prices. That is why the dual mandate is not a choice between two desirable things. It is a balance meant to deliver on a singular goal—a sustainable and expanding economy that works for everyone.” 

When the FOMC decides whether to raise, lower, or hold the federal funds rate, it’s in an attempt to deliver on this dual mandate. 

Why the FOMC raises and lowers the federal funds rate

• Raising the federal funds rate: The FOMC typically increases the federal funds rate when it is concerned about inflation—specifically, that inflation is exceeding the 2% annual target—or the economy appears to be “overheating.” A higher federal funds rate targets inflation by making it more expensive to borrow money, which tends to slow down economic activity. 
• Lowering the federal funds rate: The FOMC will lower the federal funds rate when it is concerned about unemployment getting too high or economic growth slowing down. Lowering rates makes it cheaper to borrow money, which tends to encourage economic activity and hiring as a result. 
• Leaving the federal funds rate unchanged: The FOMC doesn’t change the federal funds rate at every meeting. Sometimes, the group will leave rates unchanged because it is satisfied with the current state of inflation and unemployment or because it is waiting to see what impact previous changes are having.

What is the FOMC looking at right now?

Ahead of the planned FOMC meeting on September 17, 2025, the group is likely taking the following factors into consideration.

1. Unemployment: The labor market data released on August 1, 2025, suggested hiring had slowed down over the summer, with most of the new jobs in the healthcare sector, bringing the unemployment rate to 4.2%. That report also included revised payroll data for May and June, which showed far fewer jobs were added than initially thought, indicating a weaker labor market. (These revisions happen regularly, but the changes to the May and June numbers were unusually large.) The next jobs report is due on September 5, 2025, and the FOMC will likely be looking for additional data on the health of the labor market. Signs of continued weakness will point towards a cut, while strength could lower the probability of a cut.
2. Inflation: Meanwhile, the July consumer price index (CPI) data released on August 12, 2025, showed that inflation increased 0.2% (on a seasonally adjusted basis) over the previous month and 2.7% over last July. While prices for groceries came down slightly, prices were up in other categories like home furnishings and toys. The July producer price index (PPI) data released on August 14, 2025, showed an even sharper uptick at 0.9% over last month and 3.3% over last year, which was much higher than expected. The next CPI data is due to be released on September 11, 2025, and the FOMC will be looking for evidence that inflation is either ticking up or staying steady. An uptick would point to holding rates steady, while no change could point to a cut.

When inflation and unemployment both appear to be rising, the FOMC’s decisions can become more difficult. Typically, you would lower the federal funds rate to address unemployment, but you would raise it to address inflation. In this situation, you can expect the FOMC to weigh the risks of both inflation and unemployment in making their decision. As of early September, many predict the FOMC will decide to lower the federal funds rate at the next meeting.

Key takeaways: What changes in the federal funds rate mean for you

Now you know how the FOMC decides to raise or lower the federal funds rate. But what could those changes mean for you?

• Higher rate: A higher federal funds rate typically means higher borrowing costs, but your savings should also earn more interest.
• Lower rate: A lower federal funds rate should mean lower borrowing costs (which is good if you are taking out loans), but your savings won’t earn as much.

For more information on making the most of your money when interest rates are decreasing, check out our blog post on the subject. For our take on investing when interest rates are increasing, check out this post instead.