Interest rates are essentially the cost of borrowing money or the reward for lending it. In simpler terms, it's like the "price" you pay for using someone else's money or the "earnings" you receive for letting someone use yours. Imagine you want to borrow $100 from a friend, and they ask you to return $105 after a year. The extra $5 is the interest, and the interest rate would be 5% in this case. ## Two main types of interest rates 1. **Nominal Interest Rate**: This is the basic interest rate that you see advertised by banks and other financial institutions. It doesn't account for [[inflation]] (the general increase in prices over time). 2. **Real Interest Rate**: This rate adjusts the nominal interest rate for inflation, representing the actual purchasing power of the money you gain or lose through borrowing or lending. Interest rates are important because they influence the economy by affecting borrowing, saving, and investment decisions. When interest rates are low, people and businesses are more likely to borrow and invest, stimulating economic growth. On the other hand, when interest rates are high, borrowing becomes more expensive, which may slow down [economic activity](https://doctorparadox.net/category/economics/) as people save more and spend less. The [[Federal Reserve]] and other [[central banks]] in the United States play a crucial role in setting interest rates. They adjust rates to achieve various economic goals, such as controlling inflation or promoting growth. To sum up: interest rates are the cost of borrowing money or the reward for lending it, and they play a significant role in influencing the economy.