What the Fed actually sets
The Fed sets the federal funds rate target — the rate banks charge each other overnight. Every other rate in the economy (mortgages, credit cards, business loans, bond yields) is anchored to it.
The dual mandate
The Fed has two legal objectives, which sometimes conflict.
- →Maximum employment — low unemployment, strong labour market
- →Price stability — typically interpreted as ~2% PCE inflation
- →When inflation is high and unemployment is rising, the Fed must choose which to prioritise
Tools beyond rate cuts/hikes
Rate policy is the visible tool. Several others exist.
- →Forward guidance — telling markets what the Fed plans to do
- →Quantitative tightening (QT) — letting the balance sheet shrink
- →Quantitative easing (QE) — buying bonds to push down long-end yields (used in crises)
- →Standing repo facility — emergency liquidity tap for banks