Economic Interest Rates

By: EconomyWatch Content   Date: 5 November 2009

About The Author

EconomyWatch Content

Follow The Money

EconomyWatch, Content Team

 

  • Dot Div
  •      

The economic interest rates are federal interest rates at which banks lend federal funds to other financial institutions. These are the rates depository institutions charge each other for loans. Federal banks change these rates to control money supply. In the US, the members of the Federal Open Market Committee (FOMC) set the rates.

Economic Interest Rates: The Mechanism 

 

Thrift institutions and banks are obligated to maintain certain amount of reserves. They can be in the form of reserves with the central bank. A central bank is a banking institution which has the exclusive privilege to loan a government its currency. The outstanding liabilities and assets of depository institutions and the central bank determine the level of reserves. Usually it is 10% of the value of the bank’s demand accounts.

Economic Interest Rates: Applications

Banks do interbank borrowing to raise capital quickly. Let us suppose that a bank is interested in financing a project, but does not have the required capital. Instead of waiting to develop funds on its own, the bank can borrow from other banks at rates that are at par or higher than the central bank’s rate. When the central bank raises the central bank interest rates, banks are dissuaded from taking interbank loans. If the central bank lowers the rate, interbank lending is also boosted. With the borrowed money, banks can invest in more projects freely.

Economic Interest Rates: Comparison

The purpose of economic interest rates is the same for most central banks in the world. However, the way each of them sets rates may be different. For example, in the US, the FOMC sets the federal funds rate to implement monetary policies. In the UK, prevailing interest rates from highly credit-worthy institutions are used to calculate the LIBOR (London Interbank Offered Rate).

Financial markets closely watch central banks because any change in the economic interest rates will affect the amount of lending and the value of currencies. Particularly, the central bank rates of highly developed economies like the US and the UK are watched by all markets closely. For instance, one can see ramifications of US central bank rate changes in the Japanese markets as well.

 


  • Dot Div
  •      

Most Popular in Interest Rates

Related Links
blog comments powered by Disqus