EFFECT OF INTEREST RATE ON ECONOMIC GROWTH IN NIGERIA

EFFECT OF INTEREST RATE ON ECONOMIC GROWTH IN NIGERIA

1. 1. Background of the Study

 

The effect of Interest rate on economic growth in Nigeria has been a matter of controversy over a long period of time. Yet, what constitutes an appropriate interest rate policy still remains a puzzling question. Until the early 1970s, the main line of argument was that because the interest rate represents the cost of capital, low interest rates would encourage the acquisition of investment and promote economic growth, a notion consistent with the Keynesian and neo-classical analysis. This promoted many countries to impose interest rate ceilings at below market clearing levels.

Interest rate is a prominent feature of any economy. Interest rate change in response to a variety of economic events such as change in federal policy, crises in domestic and international financial market and changes in the prospects for long term economic growth and inflation. However, economic events such as these tend to be irregular (Keith, 1996).

Interest rate reform, a policy under financial sector liberalization, was to achieve efficiency in the financial sector and engendering financial deepening. In Nigeria, financial sector reforms began with the deregulation of interest rate in august 1987 (Ikhide and Alawode, 2001). Prior to this period, the financial system operated under financial regulation and interest rates were said to be repressed. According to McKinnon (1973) and Shaw (1973), financial repression arises mostly when a country imposes ceiling on deposit and lending nominal interest rates at a low level relative to inflation. The resulting low or negative interest rates discouraged saving mobilization and channelling of the mobilized savings through the financial system. This has a negative impact on the quantity and quality of investment. Therefore, the expectation of interest rate reform was that it would encourage domestic savings and make loanable funds available in the banking institutions. But the criticism has been that the “tunnel-like” structure of interest rate (Ojo, 1976) in Nigeria is capable of discouraging savings and retarding investment.

A study by Kham and Reinhart (1990) observe that there is a close connection between the level of investment and economic growth. In other words, a country with low level of investment would have a low GDP growth rate. The use of ryid exchange rate and interest rate controls in Nigeria in low direct investment, the leads to financial impressions in the early 1980. Fund were inadequate as there was a general lull in turn leads to the liberalization of the financial system Omole and Falokun (1999). This may have an adverse effect on investment and economic growth.

As already discussed so far, it is quite clear that an understanding of the nature of interest rate behavior is critical and crucial in designing policies to promote savings, investment and growth. It is pertinent to note that this research attempts to investigate and ascertain the impact of interest rate volatility on investment decisions in Nigeria using time series data covering from 1981-2010.

 

 

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