The Effect of Interest Rate on Savings in Nigeria

The Effect of Interest Rate on Savings in Nigeria.

ABSTRACT

This study examined the effect of interest rates on savings in Using multiple regression analysis. The study also carried out some diagnostic tests like heteroskedasticity, serial correlation test, and stability test.

This work made use of secondary data sourced from the central bank of Nigeria’s statistical bulletin from 1981 to 2014. The result of this regression analysis showed that the coefficient of interest rate was positive and the level of significance, 0.05 was less than the p-value so interest rate has a positive but insignificant relationship with savings in Nigeria.

The control variable used (GDP and government expenditure) also showed a positive but insignificant relationship with savings. This simply means that the interest rate has no significant effect on savings in Nigeria. Rather, savings are affected by low income.

Since the result shows a positive relationship between interest rates and saving, it was recommended that the central bank should adopt a policy of interest rates that will not only boost savings in Nigeria but also improve the level of investment.

This will in the long run increase the income of individuals and thereby increasing their level of savings and therefore that of the economy as a whole. Also, the government should spend more on viable projects as it increases investment, income, savings, and finally economic growth.

The government should also provide enabling environment to thrive as this will increase income thereby increasing the total savings of the country.

INTRODUCTION

Interest rates and savings are inseparably linked. They are among the economic variables that are of great importance to a large number of people, the government, business firms, entrepreneurs, foreign investors, the financial sector, and the household.

They are so important that they determine to a large extent the level of investment and the economic growth in an economy (Udude, 2015).

Interest rate is an important economic price. This is because whether seen from the point of view of the cost of capital or from the perspective of the opportunity cost of funds, the interest rate has fundamental implications for the economy either impacting on the cost of capital or influencing the availability of credit, by increasing savings (Acha and Acha 2011).

Interest rate is the opportunity cost of borrowing money from a lender to finance an investment project.

It is the price paid for the use of money. 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).

Savings is defined as that portion of income after tax, which is not spent on consumption goods. Savings can also be seen as that part of income, which is not devoted to the purchase of household items and firms (McKinnon, 1973).

Saving has been represented frequently as elastic with respect to interest so that an increase in interest rate would cause a relatively large increase in the volume of saving (Tucker, 1943).

To effectively mobilize savings in an economy, the deposit rate must be relatively high and the inflation rate stabilized to ensure a high positive real interest rate which motivates investors to save from their disposable income.

However, there are various states of interest rates in the financial system. They are generally classified into two categories: Deposit and lending rates. Deposits rates 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 the cost of loanable funds and lending margins.

A number of factors influence the behavior of interest rates in an economy. Prominent among these are the volume of savings, inflation, investment, government spending, monetary policy, and 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 upward pressure on interest rates, just as the reverse situation would tend to have a

Oresotu (1992) explains that the basic functions of interest rates in an economy in which individual economic agents take decisions as to whether they should borrow, invest, save and/or consume, are summarized by International Monetary Fund (IMF) under three aspect; namely:

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