Interest rates: mechanisms, effects, and economic applications

Interest Rates: History And Overview

One may think of 'interest rates' as merely a concern of cutting edge modern economic news. Indeed, the rate of interest has been the obsession of the business media of recent weeks. One March 21, 2005 Business Week article proclaimed, "Pop! Goes the Auto Bubble -- with oil prices and interest rates rising! (Mandel, 2005) But in actual fact interest rates are simply the percent at which an individual is charged for borrowing money, either from a bank, a human being, or another entity such as a credit card company. Interest rates are an old institution -- once, the rate of interest was called 'usury' and banned by the church. Now charging a reasonable rate of interest for borrowing money is considered a necessary fact of modern life, particularly for large, durable goods such as cars, houses, and appliances.

Unsurprisingly, the lesser the rate of interest, that is, the less one is 'charged' for borrowing money, the more attractive it is to borrow money and to spend money, money that one does not technically have in one's pocket. The higher the rate of interest, the less likely one is to borrow and spend money. Thus, when the Federal Reserve wishes to stimulate the economy it lowers the rate of interest. This makes it more attractive for people to borrow money, and less attractive to save money in savings accounts and long-term certificates of deposits. When the Federal Reserve wishes to curtail an economy that is in danger of over-expanding and heading into inflation, it increases interest rates, making saving a more valuable prospect.