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Bank rate is a term describing the interest rate a country’s central bank charges its domestic banks on loans it makes to them. The loans are usually short-term loans lasting for just a day, or even just overnight. The bank rate is important because commercial banks use it as a basis for what they eventually charge their customers for loans.

Policy makers use the bank rate to help them regulate the economy.  In fact, it is one of the primary means policy makers use to try and effect economic changes. Policy makers can stimulate the economy by lowering the bank rate. This makes loans less expensive, thus encouraging borrowing, which expands the money supply and then spurs increased spending. When policy makers fear that the economy may be growing too rapidly -- increasing the risk of inflation -- they may raise the bank rate. Raising the bank rate makes loans more expensive. This shrinks the money supply, and reduces spending, which in turn, dampens the risk of inflation.

In the United States, the bank rate is often referred to as the Fed Funds rate. The Federal Reserve, through its Federal Open Market Committee (FMOC), sets the Fed Funds rate. Investors closely watch the Fed Fund rate, because a change in the Fed Funds rate signals the Federal Reserve’s predictions for future economic growth or contraction.

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