The interest rate at which banks borrow money from a country’s central bank is known as the base, or national, rate. It is one of the main tools of monetary policy, used to curb inflation or boost the economy.
Who Sets the Rate
In most countries, the base rate is set by the central bank at one of its regular board meetings throughout the year. Central bank decisions are closely followed by the markets and the media, because of the rate changes' effect on the economy.
Federal Funds Rate
In the United States, the base, or nominal or national, rate is set by the Federal Reserve, which is the country’s central bank. Known as the Federal Funds Rate, it is a target rate banks should pay when borrowing short-term funds from each other. The actual rates are negotiated by individual banks, but they usually are close to the target rate. When banks borrow from the Fed, they pay the “discount” rate, which is slightly higher than the nominal rate.
Effects on the Economy
When the base rate goes up, banks pass the rising costs of money to consumers, who then borrow and spend less. By doing this, the central bank aims to curb inflation. When the rate goes down, money becomes cheaper and easier to borrow, which helps boost the economic activity. Higher rates also push the value of the national currency up.