What an interest rate is: the price of time

Why it matters

The newest FOMC brief on Kitalpha records a decision dated 2026-09-16: the committee said, "The Committee decided to raise the target range for the federal funds rate by 1/4 percentage point to 3-3/4 to 4 percent, in support of the Federal Reserve's dual mandate.". The two policy series on the markets pages hold the current limits of the target range as numbers, the lower limit and the upper limit. A reader who has just seen a headline about a rate decision might ask whether the rate on their own loan moved by the same amount. Answering that needs one idea: what an interest rate is a price for, and who sets which one.

The concept

An interest rate is a price. What it prices is time: the use of someone else’s money for a period. A borrower who has US$1,000 today and repays US$1,050 a year later has paid US$50 for a year’s use of the money, and the rate on that loan is 5% per year. The “per year” is not decoration. Because interest is charged for a period, it is quoted per unit of time, so that a loan for three months and a loan for ten years can be compared on the same footing. Every yield on Kitalpha’s Treasury pages and every policy rate in a central-bank brief is written this way.

Why does the price exist at all? Lending means giving up the use of money now in exchange for getting it back later, and three things justify charging for it. The lender forgoes whatever the money could have done in the meantime. The lender takes the risk that the borrower does not repay in full. And the lender takes the risk that prices rise before repayment, so that the money commands fewer goods when it comes back. Each of these pushes the price of time up or down for a given borrower and period, which is why there is not one interest rate but many.

Three rates appear again and again in the records, and they need telling apart. The first is a policy rate. In the United States the Federal Open Market Committee sets a target range for the federal funds rate, the rate at which banks lend reserves to one another overnight. The committee does not set the traded rate directly; it announces a range and the Federal Reserve steers the overnight market inside that range with the rates it administers. The effective federal funds rate is the rate actually traded, and on almost every day it sits between the two limits. The second is a market yield. When the U.S. Treasury borrows, the price it pays is set by trading, and the Treasury par yield curve records that price for each maturity from one month to thirty years. A three-month bill yield usually sits near the policy range, because both are short-term prices for money and a three-month loan is priced off the overnight rate over those three months, but it is set by the market, not by the committee. The third is a retail rate: what a bank charges a household or a business. It sits above the other two because the bank adds its own costs, the borrower’s credit risk and a margin.

Reading a policy decision, then, is reading a change in one specific price, for one specific borrower, over one specific period. Whether a household’s loan rate moves, by how much, and when, depends on links in a chain that the decision itself does not describe. The number line below places the four figures from today’s records side by side; look for where the traded rate sits relative to the two limits, and where the bill sits relative to all three.

Worked example

Take the two policy records: the upper limit and the lower limit of the target range, the upper limit as of 2026-09-17 and the lower limit as of 2026-09-17, beside the three-month bill yield of 4.16%. The steps below read the range as two numbers, measure its width in basis points, find its midpoint, place the bill yield against it, and then price a year’s use of US$1,000 at the bill’s quoted rate. Every figure is taken from the named record on the date shown.

Three things to read off the steps. The third step reads the width of the range in basis points; a basis point is one hundredth of a percentage point, and rate changes are usually described in them. The bill yield differs from the midpoint by the amount in the fifth line: usually close, because both are short-term prices for money, and rarely equal, because one is a market price and the other a policy target. And the last line is the concept itself: the quoted percentage, applied to a stated amount for a stated period, is a price in dollars for the use of that money over that time. Neither the range nor the bill is the rate on anyone’s mortgage.

Faded example

Now the third policy record: the effective federal funds rate, the overnight rate banks actually traded, as of 2026-10-15. The lower limit and the traded rate are given below. Complete the last step, which repeats the worked example’s width calculation for this pair: how far from the lower limit does the traded rate sit, in basis points?

Retrieval check

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