Higher rates reduce demand The Federal Reserve controls the federal funds rate, often referred to as its target rate. This is the interest rate that banks use to make overnight loans to each other. Banks borrow money - sometimes from each other - to make loans to consumers and businesses. So when the Fed raises its target rate, it raises the cost of borrowing for banks that need funds to lend out or meet their regulatory requirements. Banks naturally pass on these higher costs to consumers and businesses. This means that if the Fed raises its federal funds rate by 25 basis points, or 0.25 percentage point, consumers and businesses will also have to pay more to borrow money - just how much more depends on many factors, including the maturity of the loan and how much profit the bank wants to make. This higher cost of borrowing in turn dampens demand and economic activity. For example, if a car loan becomes more expensive, maybe you'll decide now is not the right time to buy that new convertible or pickup truck you had your eye on. Or perhaps a business will become less likely to invest in a new factory