CHAPTER TWO
2.0
LITERATURE REVIEW
2.1
THEORETICAL LITERATURE
2.1.1 Interest Rate Volatility and Investment Determination in Nigeria.
The variation of short-term and long-term interest rate is a prominent feature of
the
economic events such as changes in Federal Policy. Crises in domestic and international financial
market in the prospects for long-term economic growth and inflation. However, economic event such as these, tends to be irregular (Keith
1996). There is a more regular volatility of
interest rate associated with
the business cycle. The expansions and contraction that the economy
experience overtime. For instance, short- term interest rate rise in expansions and
fall
in recessions. Long-term
interest rate do not appear to be the term cyclical volatility
of
interest rates which refers to the variability
of interest rate over periods
that
correspond to the length of the typical
business
cycle.
The variation of interest rates affects decision about how to save and invest.
Investors differ in their willingness to hold risky
assets such as bonds and stocks.
When the holding stocks and bonds are highly volatile, investors who rely
on these assets to provide their
consumption
faces a relatively large chance
of having low
consumption at
any give time. For example, before retirement, people receive a steady
stream of income that helps to buffer the changes in wealth associated with changes in the returns of their investment portfolios. This steady
return from working helps them maintain a relatively steady level of consumption.
After retirement, people no longer have steady portfolios stream incolme from working hence a less
volatile
investment portfolios is called
for. The lower volatility of investment returns allows retiree to maintain a relatively even level of consumption overtime. Nigeria experienced severe macroeconomic problems
towards the end of 1970s through the first half of 1980s when output
declined
substantially. The real GDP growth rate averaged only 1.5% per annum during the period 1973-1980 (registering negative growth rate in 6 years during the
period) (CBN, 1990) In response of this deteriorating
economic situation, the
Nigeria authorities launched policy programmes contained in the Structural
Adjustment
Programme (SAP). Several
forms
of
corrective measures were undertaken including financial
sector reform policies.
Prior to 1986 in Nigeria, a common practice has been the support of certain economic projects
considered to be
essential part
of development
strategy.
Government adopted policies aimed at accomplishing specified objective such as interest
rate ceilings and selective sectoral policies. Those policies were introduced with the intension of directing credit, to priority sectors and securing in expensive funding for their activities. The ceiling on interest rates
and
quantity restrictions on loanable funds
for
certain sectors ensures that a larger share
of funds is made available for favoured sectors. Such a practice hinders financial intermediation since the financial markets will only be accommodating the credit
demands of the government
plan
ad ignoring risk. The practice has
been
disfavoured as a growth policy by the repressionist school led by Makinnoa
(1973) and Shaw (1973).
According
to
the Mckinnon (1973) and Shaw (1973) financial repression
paradym, governments effort to promote economic growth by such indiscriminate
measure have repressed financial system. This discourages
financial intermediation. Thus, the repressionist schools calls for
financial liberalization the
removal of ceiling on interest rates among others as
a growth promoting policy. According to the removal of interest rates ceiling
because the interest elasticity of
private savings
is positive.
The interest rate policy
in Nigeria perhaps
one
of the most controversial of all
financial policies. The reason for
may not be fetched because interest rate policy
has
direct bearing on many
other
economic variables such as investment decision. Interest rates play a crucial role in the efficient allocation of resources
aimed at facilitating growth and development of an economy and such as
a demand management technique for achieving both internal and external
balance.
According to Ocnenon (1973), interest rate policy is among the emerging issues
in current economic policy in Nigeria in view of the role it is expected to play in the
deregulated
economy in inducing savings
which
can be
channel
to investment and thereby
increasing employment, output and efficient financial
resource utilization. Also, interest rates can
have a substantial influence on the
rate and pattern of economic growth by influencing on the volume and disposition
of
saving as well as the volume and productivity of investment (Leahy, 1993).
Rema (1990) investigated the
theoretical and empirical determinant of private
investment in
developing countries and
identified macroeconomic and
institutional factors such as financial repression, foreign exchange shortage, lack
of
infrastructure and economic instability as important variables that explained
private investment.
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