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A Proposal on the Effect of Interest Rate on Investment and Money Demand in the Nigerian Economy

A Proposal on the Effect of Interest Rate on Investment and Money Demand in the Nigerian Economy

A Proposal on the Effect of Interest Rate on Investment and Money Demand in the Nigerian Economy

Chapter One

Objective of the study

The following objectives will be assessed:

  1. To ascertain the effect of interest rate on investment decision in Nigeria
  2. To ascertain the trend profile of investment in Nigeria
  3. To investigate the effect of interest rate on demand for money in Nigeria




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. Chetty (2004) shown that the investment demand curve is always a backward bending function of the interest rate in a model with non-convex adjustment costs and the potential to learn. At low interest rates, an increase in the rate of return raises the cost of learning and increases aggregate investment by enlarging the set of firms for when the interest rate exceeds the rate of return to delay. An increase in interest rate is more likely to stimulate investment when the potential to learn is larger and in the short run rather than the long run. Akintoye and Olowolaju (2008) examined optimizing macroeconomic investment decision in Nigeria. The study employed both the ordinary least square and rector auto regression frame works to stimulate and project inter inter-temporary private response to its principal stocks namely: public investment, domestic credit and output stocks.


Chapter Three


Any empirical study, the study and procedures that will be adopted are determine by the nature of the problem being investigated and the objective of the study. This chapter therefore describes the methodology of the study. The sources of data collected, procedures and method gathering data as well as techniques for testing the hypothesis. In other hands, the challenges posed in the study of the effect of interest rate on investment and money demand in Nigeria economy hinges on the ability to specify a reliable and dependable model to capture the relationship between the two variables and also ascertain other determinants and investment decision.


As stated, data will be analyzed using statistical tools of Simple Linear Regression model because it is utilizing for the purpose of prediction where the independent variable is used to obtain a better prediction of dependent variable (Ozo, Odo, Ani and Ugwu, 2007). This was necessitated by our use of secondary data collected from the Annual Reports and Accounts of the Central Bank of Nigeria (CBN)


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