What is a Prime Rate?

The key interest rate, also known as the central bank rate, is one of the most important instruments of monetary policy. It is the interest rate at which the central bank lends to commercial banks. The level of the policy rate has a direct impact on a country's economic activity and inflation.

How does the Prime Rate work?

When a bank needs money to carry out its daily operations, it can borrow it from the central bank. The prime rate is the interest rate at which the central bank lends this money.

When the central bank raises the prime rate, commercial banks must pay more to borrow money, which causes them to charge their customers higher interest rates on loans.

This can lead to businesses and consumers borrowing less. This slows economic growth.

How does the Prime Rate affect Inflation?

The central bank uses the key interest rate to keep inflation in check. Higher inflation means that prices for goods and services rise faster, which leads to a devaluation of money.

To combat high inflation, the central bank raises the prime rate, which causes banks to charge higher interest rates for loans and makes businesses and individuals less willing to borrow. This slows economic activity and can reduce inflation.

When is the Prime Rate changed?

The central bank constantly monitors economic trends and inflation and adjusts the prime rate when necessary.

When the economy is growing strongly or inflation is high, the central bank may raise the policy rate to prevent overheating.

When the economy is weakening or inflation is low, the central bank can lower the policy rate to stimulate growth.

> Learn more about the Business Cycle.

Conclusion

The interest rate is a tool used by central banks to influence economic activity and inflation. By making adjustments to the policy rate, a central bank can boost growth or prevent overheating.

It is important to note that changes in the policy rate can have an impact on borrowing costs, consumption, and investment.