How the Federal Reserve impacts savings account rates

Higher interest rates can boost your savings

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Inflation rates and the cost of living in the U.S. are way up — and setting aside some cash is more important than ever. That way, you have funds in case of an emergency and to cover rising expenses.

To combat inflation, the Federal Reserve has increased interest rates in recent months. While rising interest rates can be difficult for borrowers, savers can benefit by earning more interest on money held in their savings accounts.

Key insights

  • The Federal Reserve (the Fed) serves as the U.S.’s central bank and is responsible for ensuring our economy operates efficiently.
  • When the Fed thinks the economy isn’t operating as it should, it adjusts the federal funds rate, which indirectly causes interest rates to increase or decrease.
  • Changes in interest rates affect the rate you’ll pay on loans — and also the rate you’ll earn on savings and other deposit accounts.
  • Many banks are paying much higher interest rates than they have in the past.

What is the Federal Reserve?

The Federal Reserve was formed in 1913 with the signing into law of the Federal Reserve Act. The goal was to create a more effective method of supervising the U.S. banking system. The Federal Reserve is the U.S. central bank and ensures our economy operates effectively.

Robert R. Johnson, a professor of finance at Creighton University, explained: “The Federal Reserve is the nation's central bank and manages the United States' money supply. It … operates under a dual mandate, seeking both price stability and full employment.”

To ensure the U.S. economy is operating effectively and achieving its mandates, the Fed uses its monetary policies to do a few essential things:

  1. Maximize employment
  2. Promote stable prices
  3. Control long-term interest rates

It works to achieve this by adjusting the federal funds rate.

“A principal mission of the Fed is to ensure price stability,” explained Stephan Weiler, a professor of economics at Colorado State University and director of CSU’s Regional Economic Development Institute.

“The rate they set, the federal funds rate, is the amount of interest banks charge each other when making daily transactions that allow the smooth depositing and withdrawals of customers. The fed fund rate is also the baseline interest rate to which all other … rates are set, such as savings accounts, car loans and home mortgages.”

» MORE: Interest rates and how they work

The Fed rate and your savings account

The federal funds rate directly relates to your savings account because it’s the rate that helps establish two main things:

  1. How much interest banks and others charge you on loans
  2. How much these institutions pay you on deposits

“The Fed rate, or federal funds rate, is the interest rate at which banks lend reserve balances to other banks overnight,” explained Daniel Colston, the CEO of Upward Financial Planning. “The Fed sets this rate to control the money supply, manage inflation and maintain financial stability. When the Fed adjusts this rate, it has a ripple effect on interest rates throughout the economy, including the rates banks pay on savings accounts.”

He continued: “When the Fed raises the rate, banks tend to increase their savings rates. … Of course, the opposite is true as well. When the Fed lowers the rate, banks tend to lower the rates they pay on savings accounts.”

Johnson explained that while the Fed doesn't set savings rates, mortgage rates or certificate of deposit (CD) rates, its actions influence all of these rates.

“When the Fed raises the target fed funds rate, mortgage, auto and other interest rates follow,” he said.

How to make the most of the Fed rate

Increases in the Fed rate tend to lead to increased interest rates. While this can be a drawback for borrowers, it’s good news for savers. Not only do loan rates increase, but banks also tend to increase their rates on deposit accounts, like savings accounts and CDs.

“To earn the most interest, consider using high-yield savings accounts and CDs. High-yield savings accounts typically offer higher interest rates than traditional savings accounts, as they are primarily offered by online banks with lower overhead costs,” suggested Colston.

“CDs, on the other hand, require you to lock in your funds for a specified term but generally offer higher interest rates in return. It's key to analyze your situation carefully before parking your funds in a CD, as many CDs have significant early withdrawal penalties.”

» MORE: 5 things to know before opening a certificate of deposit

An example of interest rates at work

Let’s look at an example using real rates.

  • The national rate cap (maximum possible rate) published by the Federal Deposit Insurance Corporation on a 24-month CD increased from 0.94% on April 1, 2021, to 2.48% on March 21, 2022, and 6.52% on March 20, 2023.
  • The national rate cap on savings accounts for the same three periods was 0.82%, 0.83% and 5.32%, respectively.

The following examples show the maximum possible rate you might earn on a 24-month CD or a savings account using these national rate caps published by the FDIC. Note that actually getting rates this high is rare. That said, the following charts show how the amount of simple interest earned in a year would vary:

Savings account example

24-month CD example

As you can see, the maximum possible interest rates on these accounts have increased significantly in the past two years. As a result, potential interest earnings have also increased — making now an excellent time to build an emergency fund or set money aside in a savings account.

What about inflation?

The U.S. is currently in a period of high inflation, and the Fed has been raising the federal funds rate to curb inflation and stabilize prices.

What causes inflation?

How the U.S. got to the current high levels of inflation is in large part due to the pandemic and concerns that unemployment would increase and cause a recession, explained Johnson.

“At that time, the Fed moved in to reduce the target federal funds rate,” said Johnson. “This move increased the money supply, and the easing credit conditions ensured that businesses maintained operations and employment was robust.”

Now the Fed has shifted its focus from full employment to price stability, after the unprecedented increases in money supply accelerated inflation. “Remember,” explained Johnson, “inflation is best described as too many dollars chasing too few goods.”

So, when there’s a lot of money circulating but not a lot of goods accessible, prices tend to increase. Significant supply chain issues and goods shortages contributed to rising costs during the pandemic and beyond.

How inflation is curbed

In an effort to curb inflation, the Fed has implemented multiple interest rate hikes during the past year.

“In real time,” explained Johnson, “it is difficult to determine whether the Federal Reserve's actions are like the porridge in the tale of Goldilocks and the Three Bears — that is, are the Fed's actions too hot, too cold or just right.”

The Fed also doesn’t know with certainty what its actions will do to the economy, but it does its best to take action based on its knowledge at the time.

“They (the Fed) have been raising these rates to try to cool the economy from its high inflation status — and price increases have, in fact, slowly dropped since this policy shift,” added Weiler. “The problem has been that the rate hikes have only slowly reduced inflation, which means more rate hikes are likely.“

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Is the Fed going to raise interest rates again?

As of May 3, 2023, the Federal Reserve has indicated it plans to monitor the economy and consider whether future rate increases are necessary. On May 3, 2023, the Fed voted to raise the federal funds rate by 0.25% to a range of 5% to 5.25%.

The Fed regularly reevaluates the state of the economy. It changes its approach if and when necessary to promote price stability, address the level of employment and moderate long-term interest rates.

What happens if interest rates go down?

If interest rates decrease, your borrowing costs will decrease with variable-rate loans like credit cards. Interest earnings will also decrease if you have variable rates on your deposit accounts. If you have fixed-rate loans or fixed-rate deposit accounts like CDs, your interest costs and earnings will not change and will stay at the higher rates.

Which savings account has the highest interest rate?

The savings account with the highest interest rate is typically a high-yield savings account. While the exact rate you can earn will vary based on what’s happening in the economy, a rate in the range of 4% to 4.25% is among the best as of the date of publication.

As of April 17, 2023, per data reported by the FDIC, the national average deposit rate on a savings account was 0.39%, and the national rate cap was 5.58%.

Bottom line

The Federal Reserve plays a vital role in the U.S. economy. Not only do we feel the effects of its actions on the money we borrow, but we also feel it in our savings accounts.

The Fed recently raised the federal funds rate to 5% to 5.25%, and, as a result, interest rates are expected to continue to increase in the near term. While a rate increase means borrowers may pay more interest on new and variable-rate loans, savers may benefit by earning more on their deposits.

ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
  1. Federal Reserve, " About the Fed ." Accessed March 24, 2023.
  2. Federal Reserve, " Monetary Policy: What Are Its Goals? How Does It Work? " Accessed March 24, 2023.
  3. Federal Reserve, " National Rates and Rate Caps ." May 3, 2023.
  4. Federal Reserve, " Federal Reserve issues FOMC statement ." Accessed May 3, 2023.
  5. Federal Reserve Bank of New York, “ The Founding of the Fed .” Accessed March 24, 2023.
  6. U.S. Bureau of Labor Statistics, " Consumer Price Index ." Accessed March 24, 2023.
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