If you understand the processes by which the Fed influences reserves and the money supply, you also understand how it influences interest rates.

Market Prices & Interest Rates

In spite of what you may read in the papers, see on television, or read on the InternetSW, the Fed does not set (or administer) interest rates.

Market forces, not the Fed, set prices and interest rates. The Fed has significant influence in the market because it has resources unmatched by any other single player in the market. But, they can still only influence rates.

Most of the time the market and Fed activity move in tandem. But, during critical times, the Fed's influence cannot overcome market forces.

Fed Funds Interest Rates

Similarly, the Fed cannot control the interest rates for interbank loans like Federal Funds. They can only influence those rates indirectly by affecting excess reserves through their open market activities.

People frequently overstate the influence of Fed Funds Interest Rates on broader market interest rates. Since Fed Funds transactions occur between banks, over night, for limited amounts of money, they do not provide a major source of funding for bank loan activity. These rates give signals as to the relative tightness of credit markets, but they do not really influence business and consumer loan rates.