For more than a century, the Federal Reserve has steered the U.S. economy largely free from political influence. From World War II to the COVID-19 pandemic, the Federal Reserve has worked to keep the national economy sailing smoothly — in part by setting an interest rate that affects everyone.

“The Fed’s interest rate changes have a kind of direct visibility for many people in the economy who have loans, which is the vast majority of the population at some point in their life,” said James Cloyne, an expert on the Federal Reserve and a professor of economics in the College of Letters and Science at UC Davis.

But in a time of tariffs, war and other mounting economic risks, the Federal Reserve’s independence is being challenged. The outcome could affect every aspect of our economic lives, including our jobs, bank accounts, grocery bills and investments in the future. 

How does the Federal Reserve rate affect the U.S. economy?

The Federal Reserve, known commonly as “the Fed,” is the politically independent part of the federal government responsible for two key parts of the country’s economic health: keeping inflation low and employment high. It's especially important in moments of financial crisis.

The Fed’s primary tool for managing both inflation and employment is by setting interest rates on the overnight loans it makes to other banking institutions. Overnight loans are for exactly that long — overnight. Banks borrow overnight from the Fed to keep their balance sheets even.

Cloyne has published a number of studies on how changes in the Fed interest rate affects employment and the broader economy. His research has shown that higher Fed interest rates tend to lower both inflation and the business investments that create jobs. Higher rates also lower consumption and housing prices. This is true in the U.S. as well as in the U.K., which has a similar system for managing the economy. 

The rates on Fed loans reach the financial lives of everyday Americans in a couple ways. One is that interest rates for loans on cars, credit cards and everything else are based in part on a prediction of what the Fed rate will be over the life of the loan. 

The Fed’s interest rate is also a broader signal about the economy. A higher interest rate signals optimism about the future. A lower Fed rate signals that inflation is likely to rise or that the national economy is headed for trouble and more people are going to want to save than borrow. 

The Fed interest rate affects the stock market by both influencing the cost of borrowing and by acting as a signal about the economy’s future direction. But changes in the Fed rate don’t always have an immediate impact.

“The stock market is a forward-looking appraisal of the value of the United States economy,” said Cloyne. “If the Fed is moving interest rates in a way that investors fully expect, you might not necessarily see any movement in the stock market.”

Changes in the Fed rate might affect the national economy indirectly. If higher interest rates were to slow the economy, people might lose their jobs and fall behind on their mortgages and other bills. These all have downstream effects that can be amplified by high levels of borrowing, like in the 2008 financial crisis.

Federal Reserve independence in the U.S.

The Federal Reserve was founded in 1913, and after World War II has been operationally independent of the federal government. The rules for appointing and removing any member of the Board of Governors or the chair are detailed in the Federal Reserve Act. 

The Board of Governors and the Fed chair are appointed by the President of the United States, with Senate confirmation. The Fed chair himself is a member of the Board of Governors, and Fed chairs can only be chosen from among existing members of the Board of Governors. 

If a Fed governor resigns or is removed, the President can nominate a replacement. However, that replacement must be approved by the U.S. Senate. 

No member of the Fed’s Board of Governors has been removed by the President since its founding. The U.S. President’s August 2025 firing of Fed governor Lisa Cook is currently being challenged in court.

At issue has been repeated calls to lower the Fed’s interest rate, primarily directed at Fed Chair Jerome Powell. 

However, the chair of the Federal Reserve doesn’t set the Fed’s interest rate. That decision is made by seven voting members of the Board of Governors of the Federal Reserve System, which includes the chair. 

In addition, the president of the New York Fed and a rotating pool from the remaining 11 district Federal Reserve Banks across the country also have a vote. Fed presidents also respond to their local boards of directors, which include representatives from banks, the business world and non-profits. 

“The Federal Reserve chair wouldn’t be able to change the interest rate on his own,” said Cloyne. “The decision is a collective decision by the Board of Governors and voting regional Fed presidents. Business as usual has required a vote.”

Having an independent Federal Reserve has had clear benefits. Without it, a politician might choose to change interest rates for political purposes that have nothing to do with inflation or employment. 

“For many decades the Fed has operated autonomously, with monetary policy focused on the dual mandate of delivering stable prices and maximum employment,” said Cloyne. “It was felt that the monetary policy should be focused on these objectives, and not other considerations.’’