Governments set and control the interest rates in their respective countries.
This is applied in the efforts of controlling the health of the economy through a process called quantitative easing.
Quantitative easing is the process through which governments raise and lower the interests in their economies so as to control the overall stability in their respective countries.
Central banks are the essential bodies responsible in making this effective.
Central banks increase the interest rates during times of increased inflation, and lowers them when inflation is low.
When prices of goods and services within an economy increase, the purchasing power of the citizen decreases.
Purchasing power is the ability of citizens to acquire or buy goods and services.
It increases when goods are cheaper, and decreases when goods are expensive.
When the central bank lowers interest rates, consumers within a country are able to borrow more, and thus have more money to spend.
More spending from the consumers stimulates the economy to grow and as a result causes inflation.
When the inflation is too high, above certain set limits, central banks increase the interest rates.
When interest rates are increased, the consumers borrow less because the cost of borrowing money is expensive.
Consumers thus have less money to spend and the resulting price of goods and services decreases to meet the demand.
Governments do this back and forth through time when necessary so as to keep their economies stable.
Central banks dictate the effective rates that the banks and financial institutions should charge so as to avoid manipulation in the economy.
The interest rates set by the central banks are calculated based on the overall health of the economy as well as factors such as inflation.