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
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).
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