A central bank interest rate is the price of money itself: the rate a central bank charges banks to borrow, or pays them to leave money on deposit, and every other rate in the economy (mortgages, business loans, savings, government bonds) is priced off it. Cutting it makes borrowing cheaper and tends to lift growth and jobs at the cost of higher inflation; raising it does the reverse. NationCraft turns this same trade-off into a single policy-rate slider and lets a player feel both sides of it across GDP growth, unemployment, and citizen satisfaction.
This page is published by the developer of NationCraft, an economy simulation game used below as a worked example. The mechanism described is real-world monetary policy and applies whether or not you ever play the game.
A central bank interest rate, sometimes called a policy rate or base rate, is the rate at which a country's central bank lends to commercial banks, or the rate it pays those banks to hold money with it overnight. It sounds like a narrow technical number, but it sits underneath almost every other interest rate in the economy. The rate a bank offers on a savings account, the rate a mortgage lender quotes, the rate a business pays to borrow for a new factory, and the rate a government pays to borrow by issuing bonds are all priced, directly or indirectly, off the central bank's own rate. When the central bank moves its rate, commercial banks reprice their own lending and borrowing to match, and the change ripples outward from there.
Cutting the rate makes borrowing cheaper across the board. Banks can borrow more cheaply from the central bank, so they in turn lend more cheaply: mortgages ease, business loans become easier to justify, and consumer credit follows. Cheaper credit pushes both households and businesses toward borrowing and spending rather than saving, since a savings account or a bond now pays less for sitting still. That extra spending and investment tends to lift growth and lower unemployment, which is why a central bank cuts rates when an economy is sluggish or a downturn looks likely.
The cost of cheap money is inflation. When borrowing is cheap and saving is unrewarding, more money chases the same goods and services, and prices tend to climb faster. Keep rates low for too long and inflation can outrun the bank, and once people and businesses start expecting higher inflation, that expectation can become self-fulfilling: workers push for bigger raises, businesses raise prices pre-emptively, and the inflation becomes harder to unwind.
Raising the rate does the opposite. Borrowing gets more expensive, so households and businesses pull back on loans and large purchases, while saving becomes more attractive because deposits and bonds pay more for holding still. That combination tends to slow spending, cool investment, and, with a lag, bring inflation back down. It comes at a real cost though: slower growth and usually higher unemployment, since businesses that would have expanded on cheap credit hold back or cut staff instead. Higher rates also make existing debt pricier to service, for households with variable-rate loans and for the government itself, since new government bonds have to offer higher rates to attract buyers once the policy rate rises.
No single rate setting helps everyone at once. Cutting rates helps borrowers and anyone whose job depends on an expanding economy, but it hurts savers and people on fixed incomes, and it risks inflation. Raising rates helps savers and fights inflation, but it hurts borrowers and can choke off growth and jobs. A central bank is constantly weighing these two sides, usually anchored to some target inflation rate, and much of what makes the job hard is that the effects of a rate change do not show up immediately. It can take months for a change to work its way through borrowing, spending, and prices, so a bank is always reacting to where the economy is heading, not where it sits today.
NationCraft, a mobile government and economy simulator, turns this entire mechanism into a single slider the player controls alongside the income, corporate, and VAT tax rates: the central bank policy rate, adjustable from 0 to 20 percent. The simulation defines 5 percent as the neutral rate, the point at which the rate carries no extra effect in either direction, and measures every downstream consequence off the gap between the chosen rate and that neutral point.
Move the rate below 5 and the simulation loosens credit: the inflation equilibrium drifts higher, GDP growth gets a boost from cheaper credit fueling investment, and unemployment falls. Move it above 5 and the reverse happens: the inflation equilibrium cools, GDP growth is throttled, and unemployment rises. The tug-of-war between savers and borrowers is modeled directly in citizen satisfaction too. Above the neutral rate, working-age citizens absorb a credit-cost penalty from costlier borrowing, while elderly citizens gain a savings bonus from better returns on deposits and bonds. Below the neutral rate neither effect applies, so the two groups' opposing interests are genuinely inert at exactly 5 percent, not just softened at the extremes.
The rate also reaches into the simulation's debt market and reserves. A higher policy rate raises the yield the national sovereign wealth fund earns on its holdings, and it raises the rate new government bonds must offer to attract buyers, the same way real government borrowing gets pricier once a central bank tightens. Hold the rate low for long enough and simulated inflation can run hot enough to de-anchor from its equilibrium and start feeding on itself, though that spiral is mostly triggered by in-game events layered on top of a loose rate rather than the rate slider working alone. Hold it high for long enough and growth stalls out even as prices settle down. There is no rate setting in the simulation that leaves every group better off, deliberately, because there is not one in the real economy either.
A central bank interest rate is not one lever with one effect. It is the shared price behind borrowing, saving, spending, and investing across an entire economy, which is why moving it ripples into growth, jobs, inflation, and which part of the population benefits or loses out. Understanding that trade-off, rather than treating a rate cut as simply good news or a rate hike as simply bad news, is close to the whole job of running monetary policy, whether the economy in question is real or simulated on a phone screen.
It is the rate a country's central bank charges commercial banks to borrow, or pays them to hold money on deposit. Every other interest rate in the economy, from mortgages to savings accounts to government bonds, is priced off this one rate, so moving it ripples through the whole financial system.
Borrowing gets cheaper across the economy, encouraging households and businesses to spend and invest rather than save. That tends to lift growth and lower unemployment, but it also risks pushing inflation higher because cheaper credit and less rewarding savings mean more money chasing the same goods.
Borrowing becomes more expensive and saving becomes more attractive, which slows spending and investment and, with a lag, cools inflation. The cost is slower growth and usually higher unemployment, since businesses that would have expanded on cheap credit hold back, and existing variable-rate debt and new government borrowing both get pricier.
No single rate setting helps everyone. Cutting rates favors borrowers and job growth but hurts savers and risks inflation; raising rates favors savers and price stability but hurts borrowers and can slow the economy. A central bank is always balancing these two sides against an inflation target, with effects that take months to fully show up.
NationCraft gives the player a single policy-rate slider from 0 to 20 percent, with 5 percent defined as the neutral rate where it has no extra effect. Moving below neutral loosens credit, raising the inflation equilibrium and GDP growth while lowering unemployment; moving above neutral does the reverse, and also adds a credit-cost penalty to working-age satisfaction while adding a savings bonus to elderly satisfaction, plus raising sovereign fund yield and new-bond rates.
Related: why inflation spirals, best economy simulation games, games for people who like economics.