A:

In countries using a centralized banking model, interest rates are determined by the central bank.

In the first step of interest rate determination, the government's economic observers create a policy that helps ensure stable prices and liquidity for the country. This policy is routinely checked to ensure that the supply of money within the economy is neither too large (causing prices to increase) nor too small (causing prices to decrease).

Because retail banks are usually the first financial institutions to expose money to the economy, they are the principal instruments used by the central bank to manipulate the money supply. By adjusting the interest rates on the money it lends to or borrows from the retail banks, the central bank is able to regulate the supply of money to the end user (individuals and companies).

If the monetary policy makers wish to decrease the money supply, they will increase the interest rate, making it more attractive to deposit funds and reduce borrowing from the central bank. On the other hand, if the directors wish to increase the money supply, they will decrease the interest rate, which makes it more attractive to borrow and spend money. In the United States interest rates are determined by the Federal Open Market Committee, which consists of the seven governors of the Federal Reserve Board and five Federal Reserve Bank presidents. The FOMC meets eight times a year to determine the near-term direction of monetary policy and interest rates.For more information, check out the The Federal Reserve (the Fed) Tutorial.

To find out more about interest rates, see Trying To Predict Interest Rates, Forces Behind Interest Rates and How Interest Rates Affect The Stock Market.

RELATED FAQS
  1. How do central banks impact interest rates in the economy?

    In the United States, the central bank – the Federal Reserve (the Fed) – is tasked with maintaining a certain level of stability ... Read Full Answer >>
  2. What is comparative advantage?

    Comparative advantage is an economic law that demonstrates the ways in which protectionism (mercantilism, at the time it ... Read Full Answer >>
  3. How does the Wall Street Journal prime rate forecast work?

    The prime rate forecast is also known as the consensus prime rate, or the average prime rate defined by the Wall Street Journal ... Read Full Answer >>
  4. What is a basis point (BPS)?

    A basis point is a unit of measure used in finance to describe the percentage change in the value or rate of a financial ... Read Full Answer >>
  5. What's the difference between microeconomics and macroeconomics?

    Microeconomics is generally the study of individuals and business decisions, macroeconomics looks at higher up country and ... Read Full Answer >>
  6. Are secured personal loans better than unsecured loans?

    Secured loans are better for the borrower than unsecured loans because the loan terms are more agreeable. Often, the interest ... Read Full Answer >>
Related Articles
  1. Economics

    Industries That Thrive On Recession

    Recessions are not equally hard on everyone. In fact, there are some industries that even flourish amid the adversity.
  2. Economics

    Negative Interest Rate Policy (NIRP)

    A negative interest rate policy is an unconventional monetary policy tool in which nominal target interest rates are set below zero.
  3. Investing News

    What's the Fed Going to do in 2016?

    Learn about the factors that contribute to increases in the federal funds rate by the Federal Reserve and key economic indicators for 2016.
  4. Investing News

    Tufts Economists: TPP Will Reduce U.S. GDP

    According to economists at Tufts University, the TPP agreement will destroy half a million jobs in the U.S. by 2025.
  5. Forex

    The Consumer Price Index

    Find out how this economic measure can help you make key financial decisions.
  6. Economics

    Understanding the History of Money

    Money has been a part of human history for at least 3,000 years, evolving from bartering to banknotes.
  7. Economics

    How Interest Rates Affect The U.S. Markets

    When indicators rise more than 3% a year, the Fed raises the federal funds rate to keep inflation under control.
  8. Economics

    Forces Behind Interest Rates

    Interest is a cost for one party, and income for another. Regardless of the perspective, interest rates are always changing.
  9. Markets

    The (Expected) Market Impact of the 2016 Election

    With primary season upon us, investor attention is beginning to turn to the upcoming U.S. presidential election.
  10. Investing News

    Global Headwinds Hit the 6 Biggest Economies

    As of Friday, initial estimates for fourth-quarter and full-year 2015 growth in gross domestic product (GDP) are available for five of the world's six largest national economies, and for the ...
RELATED TERMS
  1. Negative Interest Rate Policy (NIRP)

    A negative interest rate policy (NIRP) is an unconventional monetary ...
  2. Tight Monetary Policy

    A course of action undertaken by the Federal Reserve to constrict ...
  3. Consumer Confidence Index - CCI

    A survey by the Conference Board that measures how optimistic ...
  4. Stagflation

    A condition of slow economic growth and relatively high unemployment ...
  5. Current Account Deficit

    A measurement of a country’s trade in which the value of goods ...
  6. Trade Finance

    The financing of international trade. Trade finance includes ...
Hot Definitions
  1. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  2. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  3. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  4. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  5. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  6. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
Trading Center