ABSTRACT
This study was embarked upon with a view to determining the impact of interest
rate on other selected macroeconomic variables in Nigeria. Data were sourced
from CBN Abuja and NBS. Data were analyzed using the ordinary least square
regression (OLS). Results indicate that: Interest rate is inversely related
investment and also negatively related with GDP. On the basis of the above
stated findings some policy recommendations were made.(1)Government
should establish policies that encourage increase in savings deposit rate,
reduction in lending rates and also, efficient and reliable financial institutions
encourage people to save. (2) The require reserve ratio should be to strengthen
the lending rate of commercial banks. (3) We recommend that the government
and financial authorities should implement policies that favour income growth
such as job creation and increase in salaries and wage increase as these will
affect investment significantly.

CHAPTER ONE
INTRODUCTION
1.1BACKGROUND TO THE STUDY
Interest rates play important role in controlling major macroeconomic variables.
The primary role of interest rate is to help in the mobilization of financial
resources and to ensure efficient utilization of resources for the promotion of
economic growth and development (CBN 1970).
However, they are various states of interest rates in the financial system. They
are generally classified into two categories: Deposit and lending rates. Deposits
rate are paid to savings and time deposits of different maturities, while lending
rates are interest rates charged on loans to customers and they vary according to
cost of loanable funds and lending margins.
A number of factors influence the behaviour of interest rates in an
economy. Prominent among these are the volume of savings, inflation,
investment, government spending, monetary policy and taxation constitute the
major source (supply) of credit while investment represents the major demand
for credit. Therefore, the level of savings partly determines the level of interest
rates. For instance, a decrease in the accumulation of loanable funds (savings) is
bound to exert an upward pressure on interest rates, just as the reverse situation
would tend to have a moderating effect. Usually, when the structures of interest
rate are changed, the resulting relative rates of return will induce shift in the
assets portfolio of both banks and the non-banks public institutions. Hence, the
direction and magnitude of changes in the market interest rates are of primary
importance to economic agents and the policy makers.
Consequently, the Nigerian Economy has been highly prone to interest rate
volatility and fragility (CBN, 2000). Interest rates of all instruments have
experienced very volatile movements. Inconsistencies have been the order of
the day (Adewunmi, 1997).
Prior to the structural adjustments programme (SAP), the level and structure of
the interest rates were administratively determined by the Central Bank of
Nigeria (CBN). Both deposits and lending rates were fixed by the bank, based
on policy decision (CBN, 1962). At that time, the major reasons for
administering interest rates were the desire to obtain social optimum resource
allocation, promote orderly growth of the financial market and combat inflation
in implementing the credit policy. During this time, the minimum rediscount
rate which was very low, averaging about 7.25 percent between 1975 and 1985.
Also, preferred sectors could not access funds because financial institutions
were unable to raise sufficient funds form the money market at the favoured
concessionary rates (Staley and Morse, 1966). Within the general framework of
deregulating the economy in 1986, in order to enhance competition and efficient
allocation of resources, the CBN introduced a market based interest rate policy
in August 1987 (CBN, 1987).The policy decision was not without controversy,
and later,it was generally agreed that low interest rates did not encourage
savings. It was feared that high interest rate which was likely to accommodate
the deregulation of interest rates allowed banks to determine their lending and
deposit rates according to market conditions through negotiations with their
customers (CBN, 1987).
However, the minimum rediscount rate (MRR) which influenced interest rates
continued to be determined by the CBN in line with changes in overall
economic conditions. The MRR which was 15 percent in August 1987 was
reduced to 12.5 percent in December 1987 with the objective of stimulating
investment and growth in the economy (CBN, august 9, 2006). During the same
period, the prime lending rates of commercial banks and merchant banks were
on the average 18.0and 20.5 percents respectively. But following the need for
moderate monetary expansion in 1989, the MRR was raised to 13.5 percent. It
was also observed that there were wide disparities in the interest rates structure
of the various banks.
As it were, the ceiling on interest rates were removed in January 1992 and
retained in 1993. Interest rate in 1993 was volatile and rose to unprecedented
level. On the basis of the foregoing developments, some measures of
regulations were introduced in 1994. The developments in interest rates within
this period were generally within the prescribed limits but the rates on the other
hand were negative in real terms since inflation was estimated to be over 50
percent.
All the same, the banks still maintained the interest rate regime in 1995 with
some modifications just to make it flexible. Nevertheless, it should be noted that
the change in interest rates were significantly different from what prevailed
during the era of regulation. Over the past three decades, high macro-economic
instability has become a key determinant and the consequence of poor economic
management. Nigeria, a country blessed with abundant natural resources is seen
as one the countries that have the most volatile macroeconomic aggregates. This
is in order with National Economic Empowerment and Development strategy
(NEEDS, 2004) which says that “between 1975 and 2000, Nigeria’s broad
macroeconomic aggregates growth, the terms of trade, the real exchange rate,
government revenue and spending were among the most unstable in the
developing world”.
It is these developments which have fuelled the need to embark upon this study.
It could be possible that the macroeconomic instability is deep rooted in erratic
movements of interest rates.
1.2STATEMENT OF THE PROBLEM
It is a well known fact that the Nigerian Economy is characterized by volatile
interest rates, macro economic instability. Several measures embarked upon by
the CBN failed to correct these defects in the economy. The most important of
these measures were contained in the amendment of the CBN monetary circular
No 21 which diverted the control of rates from CBN on August1, 1987. The
bank had been in control of the cost of credit in the economy regulating the
interest rates charged by the commercial and merchant banks in their lending
activities.
As it is, banks determination and control of interest rates on loans did not help
for the stability of major macroeconomic variables due to the volatile nature of
rates during the planning period. Currently, interest rates are market determined
and the study intend to investigate the impact of interest rate on some selected
macroeconomic variables. In view of this, the research questions are stated as
below;
1. What is the nature of the relationship between interest rates and the gross
domestic product of Nigeria?
2. What is the nature of the relationship between the interest rates and the
level of domestic investment in Nigeria?