Interests define the reward that a borrower pays to a lender or a depositor is paid by a deposit-taking financial institution above the principal sum borrowed usually at a given rate. The interest rate defines an amount that is charged by a lender for using given assets often expressed as an annual percentage of the principal amount ( Barnes & Olivei, 2017) . Interest rate has significant positive and negative impacts on the economy, noting that it can be used as a catalyst for economic growth, encouraging investing and borrowing. Additionally, interest rates can be employed to reduce purchasing power, slow down inflation, and maintain a sustainable economic expansion.
Interest rates dictate the rewards that deposits will yield for savers. Increasing interest rates makes savings more attractive since savers will earn higher rewards from the principal amount they have saved, thus encouraging savings. On the contrary, reducing the rate of interest discourages savers since their compensation for principal amounts saved reduces. Substitution takes place, noting that spending or holding cash becomes more attractive when interest rates fall ( Barnes & Olivei, 2017) . However, in the event of declining interest rates, savers foresee a fall in their incomes, noting that they get lower-income payments. For example, a pensioner who relies on interest payments yielded by savings may decide to increase his savings aiming at maintaining the income target from savings.
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Commercial banks determine the interest rate payable for deposits and interest rates charged for loans, albeit taking into account competition. Interest rates may be viewed as a function of demand and supply for loans and deposits ( Barnes & Olivei, 2017) . When loanable funds are demanded more, commercial banks will tend to increase the interest rates in efforts to encourage deposits and gain satisfactory returns from the borrowers. Declining interest rates may be put in place to discourage depositors while encouraging borrowers.
References
Barnes, M. L., & Olivei, G. P. (2017). Consumer Attitudes and Their Forecasting Power for Consumer Spending. Journal of Money, Credit and Banking , 49 (5), 1031-1058.
