If the Fed thinks that low interest rates are encouraging too much expansion or that high rates are restricting the economy, it can:
Institute a tight money policy by selling securities in the open market, reducing reserves available for lending
Indirectly change the
federal
funds rate,
the lowest short-term market rate, which is the
rate that banks in the system charge each other to borrow
money overnight
While the federal funds rate may change in response to supply and demand without Fed prodding, the Fed can cause a rate change by buying or selling Treasury securities. Buying increases the money the banks have on hand — their reserves — and thus lowers the rate and increases demand for loans. Selling reduces the reserves, increases the rate, and reduces the number of potential borrowers.
When the federal funds rate changes, it typically triggers changes in other short-term rates, and ultimately in the prime rate, long-term rates, mortgage rates, and the foreign exchange rate. That’s especially true if the financial community senses, based on what the Fed chairman and other governors say in conjunction with the action they take, that the new rate will be in effect for a period of time.
The problem is that it can take a year or more for these rate-cut changes to ripple through the economy, affecting the pace of its activity, the level of employment, and the rate of inflation.
Anthony Santomero,
Federal Reserve
Bank of Philadelphia
Anthony Santomero, 
