Interest rate

An interest rate is the cost of borrowing money, expressed as a percentage of the total amount borrowed, deposited, or lent, and is typically calculated on a yearly basis. If the interest period isn't a year, it's usually converted to an annual rate. The total interest owed or earned depends on three other factors: the principal amount, how often interest compounds, and the length of time the money is held or owed. This rate essentially measures what a borrower is willing to pay to have money now rather than later. In macroeconomics and monetary policy, "interest rate" often refers specifically to a central bank's key policy rate, like the federal funds rate set by the U.S. Federal Reserve.

There are two main ways to look at interest rates: nominal and real. The nominal rate doesn't account for inflation, while the real rate does. The real rate compares the purchasing power of the money at the time it was borrowed or lent to its purchasing power when repaid. If inflation matches the nominal interest rate, the real rate is zero. The Fisher equation calculates the real rate, and for low rates over short periods, a simple approximation is to subtract the inflation rate from the nominal rate. This equation can be used both for projected rates (ex ante) and historical rates (ex post).

The term "interest rate" is also shorthand for many specific rates. These include the overnight rate, bank rate, base rate, discount rate, coupon rate, repo rate, prime rate, yield to maturity, and internal rate of return. The base rate is usually the annualized effective rate a central bank offers on overnight deposits. The annual percentage rate (APR) can be either nominal (ignoring fees and compounding) or effective (accounting for them). The annual equivalent rate (AER), or effective annual rate, factors in compounding but not fees. The discount rate can refer to a central bank's lending window or the rate used to calculate present value. For bonds, the coupon rate is the annual coupon payment divided by the bond's face value, while the current yield divides that coupon by the bond's market price. Yield to maturity is the expected internal rate of return if a bond is held until it matures. Market interest rates can be fixed or floating, depending on supply and demand.

Central banks use interest rate targets as a key monetary policy tool to influence investment, inflation, and unemployment. They typically lower rates to encourage borrowing and spending, but very low rates can risk creating economic bubbles in real estate or stock markets. In developed economies, rate adjustments aim to keep inflation within a target range or to support economic growth without overheating.

Historically, interest rates have been set by governments or central banks. Over the last two centuries, rates have varied widely: the U.S. federal funds rate ranged from about 0.25% to 19% between 1954 and 2008; the Bank of England's base rate fluctuated between 0.5% and 15% from 1989 to 2009; Germany saw rates near 90% in the 1920s and around 2% in the 2000s; and in 2007, Zimbabwe's central bank raised borrowing rates to 800% to combat hyperinflation. Prime lending rates in the late 1970s and early 1980s were the highest recorded in centuries, surpassing previous peaks in the U.S., Britain, and the Netherlands.