South Africa’s inflation rate is usually above trading-partner norms, weighing on economic growth and pushing up sovereign borrowing costs.  With public debt at high levels, more inflation makes it impossible to lower interest rates and crowds out private sector investment.  This, in turn, makes any fiscal consolidation efforts more challenging and reduces the purchasing power of public spending. The overall result is a weaker currency, sluggish economic growth and sustained impetus to inflation.  Higher public debt has done little for economic growth and neither does inflation.

The day-to-day experience of economies around the world is that lower inflation is better for real growth and macroeconomic sustainability. Lower inflation reduces nominal and real interest rates, decreasing the hurdle rate for investment. Returns to investment and saving increase and become more predictable. Investment quality improves, as does competitiveness, generating productivity and real income gains.  Lower inflation also boosts the short-term real purchasing power of households and governments. A smaller inflation differential with the rest of the world leads to less nominal depreciation and directly reduces sovereign borrowing costs.

Embedding lower inflation now is well-timed, given our baseline forecast declines gradually and the public sector has a very large debt stock that it needs to roll over at new interest rates.  The fiscal and monetary authorities should endeavor to lower these new rates as far below their current level as possible.

Counter to that view, a lower inflation rate has been criticised as an obstacle to fiscal consolidation.  It is supposed that disinflation has a negative effect on the fiscus, as it reduces the nominal growth rate and growth in tax revenues.  The question is how large such short-run costs are relative to the gains.  We know that fast and transparent disinflation, implemented by credible monetary authorities, minimises the short-run costs and maximises the benefits.

It might also be supposed that more disinflation increases the real, inflation-adjusted, debt level, or, conversely, that higher inflation reduces real debt.  When capital markets work efficiently and financial repression is minimal, then the only way to get any change in the real debt level is by surprise inflation or disinflation.  Clearly, the larger the surprise, the bigger the impact, but the key point is that any impact is once-off and temporary.  If inflation is allowed to surprise higher, all future debt issuance will occur with a higher interest rate.

When disinflation is well telegraphed and expected, then the costs are minimised and are well below the gains that accrue from the permanently lower interest rates.  As has been documented by Arsanlap and Eichengreen in a paper for Jackson Hole in August 2023, the idea of reducing public debt with surprise higher inflation has not worked empirically.  The best route is a combination of primary surpluses and stronger economic growth supported by lower inflation.

Since economic transactions benefit from more certainty, not less, it makes sense to be more rather than less transparent, helping to remove short-run surprise costs, and accelerating changes in inflation expectations to get to better outcomes faster.  That need not entail significant short-run costs and we should not assume they persist.