On the 27th – 28th of March 2025, the South African Reserve Bank (SARB) hosted its Biennial Research Conference under the theme “25 years of Inflation Targeting: Lessons for the Future”.
In February of the year 2000, South Africa began its journey towards inflation targeting as a mandate of the reserve bank. It marked a shift in monetary policy in SA with a renewed focus on enabling more effective price stability mechanisms and economic growth in the long run. The inflation targeting mandate established a framework of a target band between 3% - 6%, intended to anchor inflation expectations. Over this period, through this framework SA has witnessed relative stability in inflation rates with evidence suggesting that this monetary regime has significantly contributed to reducing inflation volatility and fostering an environment conducive to investment.
As South Africa celebrates the silver jubilee of the inflation targeting framework, we find ourselves at a critical juncture. Against a backdrop of lacklustre economic growth, domestic political transition under the Government of National Unity (GNU), and heightened geopolitical turbulence, fundamental questions emerge. Is the current inflation target still optimal for South Africa’s economic trajectory or is a revision necessary to address structural rigidities and foster sustainable and inclusive growth? In this note, we discuss the policy issues that arose at the research conference given the need for lower inflation.
The optimal inflation target rate for South Africa
Since the adoption of the regime, monetary policy has delivered notable successes as inflation has moderated significantly, with interest rates declining from over 20% in the late 1990s to the current rate of 7.5%. The framework has also proven resilient, mitigating macroeconomic volatility during the 2008 Global Financial Crisis and the Covid-19 pandemic, thereby supporting consumption, investment and debt sustainability.
While the SARB has excelled in maintaining price stability, this success has not been matched with equivalent progress on structural reforms. Persistent unemployment, rising public debt, and a shrinking tax base continue to hinder sustainability growth outcomes. The question, is not whether inflation targeting remains relevant, but rather how it can evolve to better serve South Africa’s unique economic landscape.
Globally, inflation targeting has become the benchmark for monetary policy, with advanced economies typically targeting 2% and emerging markets averaging closer to 3%. South Africa’s 3% - 6% range is comparatively high. However, any revision must be systematic and forward-looking, acknowledging that financial imbalances, such as those stemming from administered prices, can undermine broader economic stability.
While there is no econometric model that points to the ‘optimal’ inflation rate as such, three literature considerations were discussed:
The case for a lower inflation target
A positive but low inflation rate is widely regarded as beneficial for economic activity, easing nominal rigidities and supporting debt dynamics. However, we must be mindful that sectoral disparities such as agriculture’s preference for near-zero inflation versus industry’s tolerance for higher rates complicate the selection of an optimal target.
Alignment with trading partners
Among conference speakers, many advocate for narrowing the target range towards 3%, aligning with major trading partners to reduce exchange rate volatility. Since 2005, the rand has depreciated by an average 5% annually with sharp deviations exacerbating economic instability. While the SARB introduced a 4.5% midpoint in 2017, average inflation has hovered at 5.3%, partly due to supply-side shocks like electricity shortages and administered price volatility.
The Zero Lower Bound Effect
For South Africa, a developing economy with higher equilibrium interest rates, the zero lower bound effect is less relevant. Achieving near-zero rates would require drastic inflation reduction, which would stifle economic growth.
The timing of the inflation target revision
The need to align monetary policy with an economy that grows as fast as it can sustain it, facing headwinds and fluctuating commodity prices was the burning platform for the revision. However, challenges persisted and the reviewed target was short-lived and the challenges remain. Lowering the inflation target promises medium-term growth benefits but risks short-term unemployment and GDP contraction. Thus, the timing and method of adjustment are paramount.
The Conference highlighted several critical factors including the following:
The importance of Central Bank Credibility and Transparency
A clear communication strategy is essential to anchor expectations and maintain credibility. Ad hoc revisions must be avoided as noted in 2001 when the target was temporarily narrowed to 3%-5% only to revert a year later when external shocks induce volatility. Although, a gradual approach such as a phased reduction over five years could mitigate short-term output costs while allowing for structural reforms to take hold.
Fiscal Policy Coordination
Reducing administered price volatility requires complementary fiscal reforms. Without these, monetary policy alone cannot ensure a smooth transition. Maintaining price stability need not generate the conventional trade-off between inflation control and economic growth provided the transition is well-anchored in expectations.
External Vulnerabilities
As a small and open economy, South Africa remains susceptible to global shocks. A well-signaled adjustment rather than an ambiguously communicated adjustment would bolster resilience.
Sacrifice ratios and fiscal debt levels
The general consensus among experts was that reducing inflation is broadly considered a beneficial policy for long-term economic stability. However, the primary point of contention revolved around the sacrifice ratio—the economic cost, particularly in terms of output and employment, associated with bringing down inflation. The sacrifice ratio discussion was predominantly framed within the realm of monetary policy, as central banks face the trade-off between tightening interest rates to curb inflation while managing the adverse effects on economic growth.
However, delegates also expressed that the idea of a sacrifice ratio also extends beyond monetary policy in the context of economy-wide coordination efforts. This view underscored the need for policymakers to examine the evidence-based economy-wide trade-offs in other macroeconomic spaces to balance the discussion related to the sacrifice ratio.
Furthermore, the potential benefits associated with lower inflation has implications for sovereign debt holders. Lower inflation rates reduce the erosion of the debt’s real value over time with holders of nominal bonds in particular. The resultant impact being more attractive bonds in the short-run and creating some complexity in the long-run for fiscal authorities. Therefore, policymakers will need to consider these factors in the context of sustainable debt management practices in the long-run.
The IT review process in a GNU context
The election results from the 29th of May 2024 led to the formation of a government of national unity (GNU). Laying the ground for a reconfigured environment of business and macroeconomic policy setting.
In this context, the process of adjusting the inflation target requires a collaborative effort between the Governor of the South African Reserve Bank and the Minister of Finance. The South African Reserve Bank Act of 1989 outlines the responsibilities of the SARB and the consultation that is required with the Minister of Finance to set monetary policy in SA.
The conference considered both the benefits and costs of lower inflation in creating greater competitiveness for the South African economy in the long-run. The GNU context, also raised important considerations related to central bank communication to convey such a policy proposal to broader societies and policymakers. The credibility of the reserve bank served as an important enabler and how such policy discussions are communicated became an important area of discussion and interrogation.
Regards
ABSIP Economic Desk
(Contributors: Ndumiso Kubheka & Khanyisa Phika)