Policy Interest Rate Policy rate
The interest rate a central bank sets as its main lever on the economy, targeting what banks charge each other to borrow overnight.
What it is
A policy interest rate is the rate a country's central bank targets for very short-term lending between financial institutions — money lent literally overnight. It is an administered number: a committee decides it and announces it, rather than a market discovering it through trading. In Canada it is the Bank of Canada's target for the overnight rate; in the United States it is the Federal Reserve's target for the federal funds rate. It reaches beyond the banks that borrow at it because the cost of overnight money is the starting point from which lenders price other borrowing — savings accounts, loans and mortgages. That influence weakens as terms lengthen: yields on longer-dated bonds are set by the market, which prices in where it expects the policy rate to go, not only where it sits today.
Why it matters
The policy rate is the most-watched number in macroeconomics because it sets the baseline cost of money. When it moves, short-term borrowing costs and the return on cash tend to follow. Bonds react as well, but through expectations: bond prices and yields move in opposite directions, so when the expected path of short-term rates shifts, existing bond prices reprice against it. That is why a decision markets already expected can pass with little movement, while an unexpected one moves prices sharply — and why longer-dated yields do not track the policy rate one-for-one. For a beginner, the value is in what it reveals: the direction and pace of changes signal how the central bank reads inflation and economic conditions, which is why the wording of the statement draws as much attention as the number.
How it's calculated
It is not calculated — it is decided, then announced. A committee meets on a published schedule, reviews conditions, and settles on a target: the Federal Reserve's Federal Open Market Committee by a recorded vote, the Bank of Canada's Governing Council by consensus rather than a vote. The decision is released in a public statement, with commentary explaining the reasoning. The central bank then uses operational tools — such as the interest it pays on banks' reserves — to keep actual overnight borrowing near the announced target. The published target is the official number; the rate at which banks actually transact overnight is measured separately and normally tracks it closely.