What's the Difference Between all the Interest Rates in the Newspaper?

Q: I like to read the financial section of the newspaper, but I'm confused by all the different interest rate terms I see. Base Rate? Prime Rate? Can you help me figure out what they all mean.

A: Thanks for your great question!

Before we begin, I'd like to point new readers to two resources they might find useful.

First is the article "What are Interest Rates?". It defines an interest rate as:

The interest rate is the yearly price charged by a lender to a borrower in order for the borrower to obtain a loan. This is usually expressed as a percentage of the total amount loaned.

Secondly the article "What's the Difference Between Nominal and Real? answers one of the five most commonly asked questions I receive - "What's the difference between nominal and real interest rates?" The short answer is that real interest rates are ones that are adjusted for inflation, whereas nominal interest rates are not. The interest rates you will read in the paper are nominal interest rates.

Now on to some definitions. The Federal Funds Rate is defined as:

The fed funds rate is the interest rate at which U.S. banks lend to one another their excess reserves held on deposit at the U.S.

A more extensive definition of the Federal Funds rate is found at Investorwords.com which defines Federal Funds Rate as:

The interest rate that banks charge each other for the use of Federal funds. It changes daily and is a sensitive indicator of general interest rate trends. The Federal funds rate is one of the of two interest rates controlled by the Fed. While the Fed can't directly affect this rate, it effectively controls it in the way it buys and sells Treasuries to banks. This is the rate that reaches individual investors, though the changes usually aren't felt for a period of time.

When you hear that Fed Chairman Greenspan or Fed Chairman Bernanke has "raised interest rates", they're talking about the Federal Funds Rate.

In Canada, the counterpart to the Federal Funds rate is known as the overnight rate. The Bank of England refers to these rates as the base rate or the repo rate.

The Prime Rate is defined as:

The prime rate of interest is a rate of interest that serves as a benchmark for most other loans in a country. The precise definition of prime rate differs from country to country. In the United States, the prime rate is the interest rate banks charge to large corporations for short-term loans.

The prime rate is typically 2-3 percentage points higher than the Federal Funds rate. If the Federal Funds rate is at around 2.5%, then expect the prime rate to be around 5%.

The short rate is related to the prime rate:

The short rate is an abbreviation for 'short term interest rate'; that is, the interest rate charged (usually in some particular market) for short term loans.

Those are the major interest rates you will see discussed in the newspaper. Most of the other interest rates you see will usually refer to a interest-bearing financial asset, such as a bond.

I hope these definitions answer your interest rate questions. If you have a question about interest rates or economics please contact me by using the feedback form.