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CHAPTER ONE

INTRODUCTION

1.1   BACKGROUND OF THE STUDY

Interest rate policy in Nigeria is a major instrument of monetary policy with regard to the role it play in the mobilization of financial resources with the aim to promote economic development and growth. Interest rate due to it importance in the financial sector of the economy can be a major tool in promoting growth and development of the economy.

        Prior to August 1986 interest rate in Nigeria  was generally fixed by the Central Bank of Nigeria with periodic adjustments depending on the government sectoral priorities (Ucendu 1993).        On 31 July , 1987, however the Central Bank of Nigeria announced the deregulation of interest rate, that is abolished (with effect from 1 August 1987) all control on SAP during the Ibrahim Babangida regime, stated that interest rate became market driven that is, hence be determined by the forces of demand and supply.

        Again, it also focuses on trade liberalization in order to stimulate exports and correct price distortions, the need for financial liberalization was also realized. The steps that were taken in this regard were interest rate deregulation, introduction of an auction market for treasury bills, the identification of insolvent bank for restructing, the introduction of  more stringent prudential guideline  for Bnaks, increase in banks minimum capital requirement and up grading and standardization of accounting  procedures. Not all of these measures were implemented simultaneously however, interest rate deregulation was the first step.

        However, in a policy reversal, the government in January 1994 out rightly introduced some measure of regulation of interest rate management. It was claimed that there were it wide variations and unnecessarily high rate under the complete deregulation of interest rate immediately, deposit were once again set at 12% - 15% per annum, while a ceiling of 21% per annum was fixed for lending.

        The cap on interest rate introduced in 1994 was retained in 1995 with a minor modification to allow for flexibility. The cap stayed in place lifting remained in force in 1997, thus enabling the pursuit of flexible interest rate regime in which bank deposit and lending rate were largely determine by the forces of supply and demand for fund.

        Since 2004, the monetary policy committee of the central bank in Nigeria has been meeting to deliberate and if possible fix the monetary policy rate depending on the performance of the economy (CBN website). In 2004, the lending rate was 20% while the minimum rediscount rate (MRR) was 15% the time deposit rate for the same period was 10.8% while saving rate was 4.9% (NDIC 2002 Annual Report).

        The adoption of the two interest rate regime in Nigeria provides a case study for Keynesian investment theory as well as Mckinnon and Shaw hypothesis. Hence, many reason abound while people and interest, these include the direction of interest rate, the expected rate of return from such investment etc.

                This work will focus on the understanding and identification of the relationship that exist between the interest rate, saving and investment the Keynesian theory implies that low interest rate as a determinant to increase investment demand.

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