Interest Rate
An interest rate is the amount that the borrower is obliged to pay to the lender; it is a percentage of the principal loaned for a certain period of time.
Why Is the Interest Rate Important?
Take, for example, a commercial bank whose business model is based on loans and repayments. You invest money and act as a lender, receiving interest as the bank lends your money to other people. If you borrow money from a bank, you pay it interest.
Commercial banks do not have enough flexibility to set an interest rate. The interest rate is set by central banks, which support the economy through various mechanisms, including by raising or lowering the interest rate.
A reduction in the interest rate will stimulate spending during a period of stagnation, as individuals and legal entities are encouraged to borrow and spend money.
Lowering the interest rate is a good short-term step to stimulate the economy. However, a low rate can cause inflation, as credit becomes more affordable while the supply of resources remains the same. In other words, demand for products grows, but supply does not. Prices rise until a balance is established.
Negative Interest Rate
A negative interest rate is a rate below zero, when the bank effectively charges depositors or pays borrowers for loans. It is unprofitable for banks to give loans or hold funds under such conditions. This is an extreme measure in order to solve the problems of the economy.
When a negative interest rate is established, people start taking out loans and buying, positively affecting the economy.