Central-bank interest rates
Reducing interest rates has also been shown to be a valuable tool to control economic growth.
When a central bank decides that an economy is growing too slowly, it can simply reduce the interest rate it charges on loans of central bank funds to banks, referred to as the discount rate in the U.S.
When banks get this "cheaper" money, they are able to make cheaper loans to businesses and consumers, providing an important stimulus to economic growth.
Likewise, by raising interest rates, a central bank can slow down the economy by making it more "expensive" for businesses and consumers to borrow money, consequently reducing purchases of homes, cars, vacations, and factories.
Interbank rates (Europe) or Fed funds rates (U.S.)
The central-bank interest rates tend to change the interest rates throughout the economy at large.
The interest rates on loans made between banks - called interbank rates in Europe and Fed funds rates in the U.S. -
- will rise whenever banks have to pay more to borrow from the central bank and
- will fall when they have to pay less.
The higher cost of money is almost always passed on to consumers and businesses in the form of higher interest rates on every other form of loan in the economy.
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