Interest is the charge for the privilege of using borrowed money, expressed in interest rate as an annual percentage of fee. Interest is provided as a compensation for lender forgoing other uses of their funds.
Calculations of interest rate vary by the type of interest:
- Simple interest – taking no compounding into account
- Compound interest – taking yearly compounding into account
Real interest is lower than nominal interest as a result of inflation.
Real interest = Nominal interest – Inflation rate
In macroeconomics, as the price of money, interest rates is the main determinant of investments. If interest rates increase, investment decreases due to the higher cost of borrowing. Central bank is in charge of setting overall interest rate.