This economic note is based on a working paper published by the authors. For a deeper dive into the research, see Working Paper 922.
In recent years, South Africa’s inflation target has moved from being a technical monetary policy detail to the centre of an important public debate. Between 2023 and 2025, discussions between the South African Reserve Bank (SARB) and the National Treasury focused on whether the country should lower its long-standing inflation target range of 3–6 per cent to a point target of 3 per cent. A natural question followed: would a lower inflation target help or hurt the economy?
New evidence suggests that, if done credibly, lowering the inflation target can support economic growth over the medium term—without imposing large or lasting costs in the short run.
The analysis draws on South African data since the introduction of inflation targeting in 2000 and examines how the economy responds when the inflation target is credibly lowered. Rather than focusing on policy announcements alone, it looks at changes in medium-term inflation expectations, which reflect what households, firms, and investors believe inflation will be over the longer run. When a central bank is credible, these expectations effectively reveal the inflation target the public believes in.
The first concern often raised about lowering inflation is the risk of weaker growth. In the short run, tighter monetary conditions can reduce economic activity—a cost economists refer to as the “sacrifice ratio.” The evidence for South Africa does show a small initial slowdown when the inflation target is reduced. However, this effect is modest and short-lived. After about a year, economic output begins to rise, peaking at roughly 1.2 per cent above its previous path after two years, and remaining higher for several years. In net terms, the economy ends up stronger, not weaker.
Lowering the inflation target also delivers what it promises: lower inflation. Both inflation expectations and actual inflation decline in a sustained way. Interestingly, policy interest rates initially move in the same direction as inflation, rather than opposite to it. This pattern—sometimes called “Neo-Fisherian”—has been observed in other countries and reflects the idea that when inflation expectations fall in a credible way, nominal interest rates can also fall without generating instability. In South Africa’s case, however, these effects are not especially persistent.
One area where expectations should be tempered is long-term borrowing costs. Lower inflation does not, by itself, lead to permanently lower long-term government bond yields. The analysis shows that changes in the inflation target explain only a small share of movements in long-term interest rates. Instead, fiscal fundamentals—such as debt levels and budget credibility—play a much larger role. This means that while monetary policy can help, it cannot substitute for sound fiscal policy.
So where do the growth gains come from? Two channels stand out. First, lower inflation expectations support higher asset prices, including equities and housing. This increases household wealth and supports consumption. Second, a credible lower inflation target reduces sovereign risk over time. As public debt dynamics improve and inflation credibility strengthens, risk premia decline, easing funding conditions for banks and supporting credit growth. By contrast, the exchange rate plays a relatively minor role, reflecting improved monetary policy credibility and lower pass-through from exchange rate movements to inflation.
The policy implications are clear. Credibility is everything. The benefits of a lower inflation target depend critically on the public believing that it will be maintained. Well-anchored inflation expectations limit short-term costs and unlock medium-term gains. Policymakers should also be realistic: a lower inflation target will not automatically deliver cheaper long-term borrowing. That requires complementary fiscal discipline and credible debt stabilisation. Finally, the importance of financial and sovereign risk channels highlights the need for close coordination between monetary and fiscal policy.
Overall, the evidence suggests that South Africa’s move towards a 3 per cent inflation target can support medium-term economic growth without imposing large short-term costs. But the gains do not come primarily from permanently lower interest rates. They come from improved credibility, reduced sovereign risk, and stronger asset prices. To fully realise these benefits, the lower inflation target must be matched by a firm commitment to fiscal sustainability.
