Interest rates can be looked at in two different but important ways. If you’re borrowing, an interest rate is just the cost you pay for borrowing money. On the other hand, if you’re the lender, then the interest rate is the compensation or profit you get for providing the service of lending money, as well as taking on the risk of lending it. In both of these cases, loans and their interest rates are what keep the economy moving, since they encourage borrowing, lending, and spending. However, the prevailing interest rates are always in a state of flux. Also, various kinds of loans have their own differing interest rates.
The levels of interest rates are simply a factor in the supply and demand of available credit across the economy. When there is more demand for credit or money, then interest rates go up. Likewise, when demands for credit go down, interest rates also go down. Also, when how much credit is available grows in total volume, interest rates go down. However, when the supply of credit goes down, interest rates go up.
Interestingly, the credit supply can go up because people save more money. Most bank accounts are actually just lending money to their banks. Banks can use money from checking accounts, saving accounts, and certificates of deposit for investment activities. The more money there is here, the less it costs to borrow.
Inflation is something else that impacts interest rate levels. When inflation rates are higher, interest rates tend to rise as well. This happens since lenders tend to ask for higher interest rates for compensation, since the purchasing power of the money they get repaid will be diminished in the future.
The federal government also has quite a bit of influence on interest rates. The United States Federal Reserve, often simply just known as the Fed, frequently makes public announcements regarding how monetary policy is going to impact interest rates.
Institutions lend each other money regularly, sometimes just overnight. These very short-term loans are done at the federal funds rate, and this impacts the interest rate which banks set on any money that they lend out. This eventually trickles down through the economy into many other various short-term lending rates. The Fed has influence over these rates based on ‘open market transactions’, and those are simply just the selling and buying of United States securities that were previously issued.