South Africa’s Inflation Shift: Short-Term Sacrifices, Long-Term Gains, Says IMF Study

The IMF study finds that lowering South Africa’s inflation target from 4.5% to 3% may cause modest short-term output losses but deliver long-term gains through lower borrowing costs and stronger investment. Success hinges on the South African Reserve Bank’s credibility, effective communication, and coordinated fiscal discipline.

The International Monetary Fund’s African Department, in collaboration with the South African Reserve Bank (SARB) and the National Treasury, has released a working paper titled “Macroeconomic Effects of Lowering South Africa’s Inflation Target”. Authored by Jana Bricco, Mario Mansilla, Delia Velculescu, and Philippe Wingender, the study employs the IMF’s Global Integrated Monetary and Fiscal Model (GIMF) to simulate how reducing South Africa’s preferred inflation target from 4.5 to 3 percent could affect growth, inflation, and fiscal outcomes. The research, enriched by discussions at the SARB-NT-IMF Workshop on Macro Models, presents a nuanced analysis of short-term costs and long-term gains, emphasizing the role of credibility and fiscal coordination.

A Strategic Shift in South Africa’s Monetary Policy

Since 2000, South Africa has operated within a 3–6 percent inflation band, refining its focus in 2017 to the 4.5 percent midpoint. In July 2025, amid declining inflation and expectations, the SARB announced its intention to target the lower bound, 3 percent. This decision mirrors global peers such as Brazil, the Czech Republic, and Indonesia, which have progressively narrowed their inflation bands to strengthen monetary credibility. Policymakers and researchers, including Honohan and Orphanides (2022), argued that South Africa’s wide target range permitted excessive variability and contributed to higher inflation risk premia. The National Treasury’s Macroeconomic Policy Review (2024) also endorsed a reassessment, while academics like Hall (2025) and Burger (2025) recommended lowering the target to around 3 percent to align with trading partners and stabilize expectations.

How the IMF Model Simulates the Transition

The IMF’s Global Integrated Monetary and Fiscal Model is a dynamic stochastic general equilibrium framework designed to capture how monetary and fiscal policies interact in an open economy. For South Africa, the model incorporates households, 60 percent of whom are liquidity-constrained and spend all their income, firms facing price rigidities, and a government balancing growth with debt sustainability. Data from the OECD Inter-Country Input-Output Database (2023) and IMF fiscal statistics were used to calibrate the simulation. The model’s realism lies in its ability to trace how expectations, interest rates, and investment respond to the shift in policy over both the short and medium term.

Short-Term Pain, Long-Term Gain

The simulations suggest that lowering the inflation target to 3 percent would initially reduce output and consumption, as lower inflation expectations suppress real incomes and dampen spending. The output decline, however, is moderate and temporary. Lower real interest rates stimulate investment, allowing capital accumulation to lift growth over time. In the medium term, inflation and borrowing costs decline permanently, and the government’s interest payments fall by about 0.6 percent of GDP. The estimated “sacrifice ratio”, the short-term output loss for every percentage point reduction in inflation, is around 0.6, broadly consistent with empirical findings from SARB research. The model underscores that these costs can be minimized if the central bank’s communication is credible enough to quickly anchor expectations, reducing the need for aggressive tightening.

Credibility and Risk Perception: The Key Variables

A central insight from the IMF paper is that the cost of disinflation depends heavily on the credibility of the central bank. If agents in the economy are fully forward-looking and trust the SARB’s commitment to the new target, output losses are minimal and the sacrifice ratio drops close to zero. If, however, expectations adjust slowly, the ratio exceeds one, signaling higher short-term costs. The study also models how markets respond through inflation risk premia. A credible commitment that reduces risk premia by 25 basis points over five years could drive stronger investment and medium-term output gains of up to 0.8 percent. Under these conditions, the transition occurs without measurable output loss. The findings echo international experience, credible, transparent, and well-communicated frameworks can substantially lower the cost of moving to a tighter target.

Fiscal Discipline Strengthens the Outcome

The paper further examines how fiscal consolidation interacts with disinflation. A spending-based consolidation of 1.8 percent of GDP over three years, implemented alongside the new target, slightly deepens the near-term output dip but reinforces credibility and helps lower inflation faster. This combination reduces the marginal sacrifice ratio, turning it negative (-0.3) when expectations are forward-looking and keeping it modest under more cautious scenarios. Fiscal restraint thus complements monetary tightening, as both policies reinforce investor confidence and lower debt-servicing costs.

A Roadmap for Stability and Growth

Drawing on global experiences, from Brazil’s gradual “glide path” to Canada’s enduring 2 percent target, the IMF study argues that South Africa’s move toward a 3 percent inflation target is both timely and feasible. The success of this shift will depend on safeguarding the independence of the South African Reserve Bank, maintaining consistent policy communication, and coordinating fiscal strategies to sustain credibility. While the adjustment entails short-term costs, these are outweighed by longer-term benefits: lower borrowing costs, higher investment, and a more stable economic environment. The IMF concludes that if credibility is preserved and expectations are well managed, South Africa can transform this monetary shift into a cornerstone of sustainable and inclusive growth, reaping the rewards of greater price stability and investor confidence.