What is interest?
Interest is a fee for lending money. When you take out a loan from the bank to buy a house, you pay mortgage interest. And when a business purchases a new machine with a bank loan, it pays borrowing interest.
It also works the other way round: if you have a savings account, your bank pays you interest on your savings. You are lending your money to the bank, after all.
Interest is also known as the cost of money.
Who or what sets interest rates?
It is the market that primarily determines how high or low interest rates are. More precisely, interest rates depend on the supply and demand for loans and savings. If savings are in great supply or if there is little demand for loans, interest rates are low. And if demand for loans increases, interest rates go up.
Interest rates, the cost of credit, move according to the law of supply and demand just like the cost of any other product. Take cardboard, for example. Demand has increased because we are doing more and more shopping online, and all those purchases are packed in cardboard for shipping. At the same time, supply has decreased due to the scarcity of paper. The result: the price of cardboard went up.
Apart from the market, central banks also influence interest rates. In the euro area, the European Central Bank (ECB) does so by setting what is known as the key policy rate. This interest rate determines the fee commercial banks pay when they borrow money from the ECB or from the central banks of euro area countries (this is called the refinancing rate). The key policy rate also determines the interest rate banks receive when they "deposit" money with the central bank (known as the deposit facility rate). The same key policy rate applies in all countries that use the euro, including the Netherlands.
Only banks are directly affected by the key policy rate, but its level also ultimately affects the interest rates paid by consumers and businesses. So the interest rate set by the ECB affects the savings rate you get, how "expensive" your mortgage is or the interest charges a business pays for a loan.
Generally, you pay a lot more interest than the key policy rate set by the ECB. With a mortgage, for example, the bank incorporates its costs into the interest rate and, of course, it wants to make some profit on the loan. The bank also charges a little extra in the form of a risk premium in case something goes wrong during the term and you can no longer repay the loan.
Development of interest rates and inflation and factors affecting both