An interest rate is fee that is incurred from borrowing money and the current government interest rates are set by the treasury department of the state. To understand it in a simpler way, an interest rate is compensation in money form for the risks and services of lending money to an individual or institutions. Without an interest rate, lending institutions would not have an incentive to lend money to people because they would run the risk of not earning income from this facility. An interest rate is normally calculated as a certain fraction of the total principal amount or as a reducing balance of the principle over a period of time, mostly a year.
Interest rates offered during a certain period of time always keep changing. The government usually plays a big part in the rate of interest on loan facilities. Different types of loan facilities will offer different rates of interest. In whichever side of the financial field that you fall under, whether borrower or lender, it is highly advised that one understands the reasons that the changes are experienced as well as the differences in the rates of interest.
Lenders of funds take the risk of lending funds to its clients and the clients not paying up the loan. Interest therefore acts as a compensation for the risk that is borne by the lender. Another risk that the lender carries when lending funds away is inflation that can be experienced within the duration of the lending facility. The prices of services and products can go up within this period and the original worth of the loan goes down. Interest rates would likewise go up depending on the inflation rate in order to cushion the lender from possible losses.
On the other hand, a borrower pays interest rates because they are given the opportunity to use the funds now and not in the period it takes to repay the loan or having to save up the amount of money that they originally borrowed. They agree to pay the interest that is prevailing at the time of borrowing the money. The rate should be acceptable during such a time and it should not be very high. Thus interest rates are an income to one party and a cost to the other party.
The government is very much involved in determining the rate of interest within its financial institutions as well as other private institutions. The federal funds rate which is the peg rate that is used by institutions in charging extremely short term borrowed facilities, eventually affects what the banks charge to its customers. The government uses open market transactions policies which are regulation for buying and selling of previously issued United States security. Once the government buys securities, banks are fueled with more funds to avail to the public and in this way, the rates decrease. The reverse is experienced with the government sells securities.
Other reasons that affect the interest rates include political short term gains, deferred consumption, alternative investments and liquidity preferences. All these issues are taken into consideration when coming up with the current government interest rates.