Interest Rate

What does Interest Rate mean?

An interest rate is a percentage of the principal charged for the use of borrowed money or earned on invested money. When you borrow money, the interest rate determines how much you pay back over and above the amount you borrowed. When you invest money, the interest rate determines how much you earn over and above the amount you invested.

Interest rates are typically quoted as an annual percentage, but they can also BE quoted over shorter or longer periods. For example, a loan may have an interest rate of 10% per year, or 0.83% per month.

There are many different types of interest rates, including:

• Prime rate: This is the interest rate that banks charge their best customers for loans.
• Federal funds rate: This is the interest rate that banks charge each other for overnight loans.
• Discount rate: This is the interest rate that the Federal Reserve charges banks for loans.
• Treasury bill rate: This is the interest rate on short-term government bonds.
• Certificate of deposit (CD) rate: This is the interest rate that banks and credit unions offer on savings accounts.

Applications

Interest rates are used in a variety of applications, including:

• Loans: Banks and other lenders use interest rates to determine how much they will charge borrowers for loans. The higher the interest rate, the more the borrower will pay back over and above the amount they borrowed.
• Investments: Investors use interest rates to determine how much they can earn on their investments. The higher the interest rate, the more the investor will earn over and above the amount they invested.
• Economic policy: Governments use interest rates to influence the economy. Raising interest rates can slow down economic growth, While lowering interest rates can stimulate economic growth.

History

The concept of interest has been around for centuries. The earliest known example of interest being charged on a loan dates back to ancient Mesopotamia, where merchants would charge interest on grain loans.

In the Middle Ages, the Catholic Church forbade the charging of interest on loans, as it was considered to be usury. However, this prohibition was widely ignored, and interest rates continued to be charged on loans throughout the Middle Ages.

In the 16th century, the Protestant Reformation led to a loosening of the Church’s prohibition on usury. This led to a surge in lending and borrowing, and interest rates began to play a more important role in the economy.

In the 18th and 19th centuries, the development of the banking system led to a further increase in the use of interest rates. Banks began to offer loans to businesses and individuals, and they charged interest on these loans.

In the 20th century, the Federal Reserve System was established in the United States. The Federal Reserve is responsible for setting the federal funds rate, Which is the interest rate that banks charge each other for overnight loans. The federal funds rate has a significant impact on the economy, and it is often used by the Federal Reserve to influence economic growth.