Interest Rate

An interest rate is the price a borrower pays for the use of money they borrow from a lender, for instance a small company might borrow capital from a bank to buy new assets for their business, and the return a lender receives for deferring the use of funds, by lending it to the borrower.

Interests rates are fundamental to a Capitalist society and are normally expressed as a percentage rate over the period of one Gregorian year.
Interest rates targets are also a vital tool of monetary policy and are taken into account when dealing with variables like investment, inflation, and unemployment.

Reasons for interest rate change

Output and unemployment

Interest rates are the main determinant of investment on a macroeconomic scale. Broadly speaking, if interest rates increase across the board, then investment decreases, causing a fall in national income.A government institution, usually a central bank, can lend money to financial institutions to influence their interest rates as the main tool of monetary policy. Usually central bank interest rates are lower than commercial interest rates since banks borrow money from the central bank then lend the money at a higher rate to generate most of their profit.By altering interest rates, the government institution is able to affect the interest rates faced by everyone who wants to borrow money for economic investment. Investment can change rapidly in response to changes in interest rates and the total output.

Money and inflation

Loans, bonds, and shares have some of the characteristics of money and are included in the broad money supply.By setting it, the government institution can affect the markets to alter the total of loans, bonds and shares issued. Generally speaking, a higher real interest rate reduces the broad money supply. Through the quantity theory of money, increases in the money supply lead to inflation.