Quantifying the impact of restrictive monetary policy on the South Africa economy since 2022 (part 3)
- Inclusive Society Institute
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SECTION D
Calculation of GDP impact via a lower household debt cost ratio
In addition to quantifying the negative effect of the high interest rates experienced since 2023 by means of econometric modelling, a second method was utilised to determine the difference between South Africa’s actual GDP and what it could have been if monetary policy had been less restrictive. At the outset, it should be borne in mind that demand inflation was vitually absent since before the Covid-19 pandemic in 2020.
The basis for this method was to determine two realistic alternative values for the average ratio of household debt servicing costs to disposable incomes since the first quarter of 2023 (when the negative impact of the repo rate increases started to appear).
Table 7 provides the results of this exercise, together with explanatory notes.
The differences between these values and the actual were then utilised to calculate the values for disposable incomes that would have existed in the presence of a less restrictive monetary policy approach (table 8).
Table 7: Calculation of the spread between the actual ratio of debt service cost to disposable incomes of households (%) under two scenarios (basis points)
(Note 1: Scenario 1 is based on the sum of the average spread of the household debt cost servicing ratio to disposable incomes between South Africa and the US for 2021 and 2022 and the actual debt cost/disposable income of the US in the second quarter of 2025)
(Note 2: Scenario 2 is based on the household debt servicing cost ratio in the first quarter of 2020 (prior to the Covid-19 pandemic and the record high interest rates of 2023))
(Sources: SARB; Federal Reserve Bank of St Louis; own calculations)
Table 8: Calculation of additional household disposable income at constant 2025 prices emanating from a lower ratio of debt service costs to household disposable income under the two scenarios in table 7
Sources: SARB; Stats SA; Federal Reserve Bank of St Louis; own calculations
Under the realistic assumption of a unitary marginal consumption propensity, the latest input/output table multipliers before the Covid-19 pandemic were then applied to these calculations to quantify the values for GDP; employment; and taxation revenues that were foregone as a result of unwarranted restrictive monetary policy, yielding the results in table 9:
Table 9: Calculation of the increase in South Africa's GDP; employment; and fiscal revenues emanating from the additional household disposable income determined under the two scenarios in table 8
(Note: The increases in GDP, employment and tax revenues are based on the 2019 input/output table multipliers (prior to the Covid-19 pandemic))
(Sources: Quantec data; own calculations)
CONCLUSIONS
Precis – self-inflicted economic pain
In the conducting of this economic impact assessment lies a sincere hope that government leaders in general and National Treasury’s executive leadership in particular, will heed the magnitude of the damage inflicted on citizens and businesses as a result of the restrictive monetary policy stance that commenced in 2015 and intensified since 2024.
The key issue at stake is the pervasive role that the benchmark interest rate plays in the spending and investment decisions of consumers and businesses, combined with the apparent unbridled power of the Monetary Policy Committee (MPC) to harm the financial disposition of South African citizens. When the MPC decided to raise the prime overdraft rate from 7% in November 2021 to a 15-year high of 11.75% in May 2023 (automatically, via the official repo rate), a predictable and sharp decline in overall economic activity occurred, leading to real GDP growth dropping to barely above zero.
In order to grasp the impact of this interest rate increase, it is useful to determine the additional debt cost burden inflicted on credit holders. As at the end of June 2025, total mortgage advances of South African banks stood at R1,918 billion. When a rate increase of 475 basis points is applied to this figure, it translates into an additional annual debt cost burden on borrowers (mostly home-owners) of R91 billion. Bank overdrafts and other loans (mainly for business owners) was valued at R2,067 billion in June 2025, representing an additional annual debt cost burden of R98 billion. This tallies up to R189 billion that would have been added to private consumption expenditure and capital formation, with a huge fiscal revenue backflow to assist with the repair and expansion of the country’s infrastructure.
In evaluating the actions of the monetary authorities, it is important to point out that a decisive shift has occurred over the past decade in the conduct of monetary policy. Ever since the retirement in 2015 of the previous Governor of the Reserve Bank, Me Gill Markus, the balanced approach towards the level of short-term interest rates has been systematically discarded.
The appointment of a new Governor of the Reserve Bank by former pres. Jacob Zuma in 2015 was immediately followed by a more restrictive monetary policy stance. The real prime rate increased from an average of 3.1% in 2014 to an average of 5.1% in 2017; 6% in 2019 and 8.3% in March 2025. Although it has subsequently declined to 7.1% (as at the end of September 2025), the real cost of credit to home-owners and of capital investment by businesses remains more than 100% higher than in 2014.
The frustration that has been experienced by holders of mortgage loans and overdraft facilities is amplified by the fact that South Africa experienced virtually no sign of demand inflation over the past decade. This study has confirmed that the increase in the consumer price index to above 7% in 2022 was solely due to the worst combined increases in global freight shipping rates and oil prices in history. These price increases were eight-fold and five-fold, respectively, due mainly to the lockdowns induced by the Covid-19 pandemic and the military invasion of Ukraine by Russia, which has been condemned by the United Nations.
The fact that South Africa’s monetary authorities followed the cue of the Federal Reserve in the US with systematic increases in the respective official bank rates suggests that there is a lack of proper understanding of the vast differences in economic prowess between the two countries. It takes the US merely five days to produce the equivalent of South Africa’s annual GDP. Furthermore, the US possessed the fiscal ability in 2020 to provide every registered US taxpayer with comprehensive financial relief during the Covid-19 pandemic, which prevented the higher cost of credit from lowering demand in the economy – unlike the case in South Africa and several other emerging markets.
Real GDP in the US increased by 2.5% in 2022 and then gained momentum to grow at an average of 2.9% the following two years. In South Africa, real GDP grew at 2.1% in 2022 but then the economy succumbed to record high interest rates to drop to 0.8% in 2023 and 0.5% in 2024 – negative in per capita terms and insufficient to generate meaningful employment creation.
Section A
Key conclusions drawn from the literature study and analysis of theoretical principles underpinning the different approaches to monetary policy in advanced economies (AEs) and emerging market & developing economies - EMDEs (including relevant data sets):
Interest rates are a crucial aspect of modern economies, as they influence the cost of borrowing, investment, and spending decisions made by individuals, firms, and governments. As a result, the level of commercial lending rates exerts both a direct and an indirect impact on total demand, total output, employment and the valuation of financial assets. Ultimately, changes to interest rates also change income distribution patterns and therefore also the level of income inequality in society.
In 2022, South Africa’s real GDP growth rate was 62% of the average for upper middle-income countries. In 2024, this ratio has shrunk dramatically to 12%.
The global spike in inflation that occurred shortly after the worst of the Covid-19 pandemic and the Russian military invasion of Ukraine was caused almost exclusively by increases of roughly 700% and 400%, respectively, in the prices of global freight shipping and oil – a combined occurrence of historic proportions.
The subsequent decline in the consumer price indices in virtually all countries was not engineered by higher interest rates but were the result of steep declines in producer price indices – caused by a predictable eventual normalisation of oil prices and global freight shipping charges.
Empirical evidence has cast doubt on the usefulness of surveys on inflation expectations for monetary policy decisions, especially due to the volatility and unreliability of such forecasts, as well as substantial ex post deviations between forecasts and actual inflation levels.
Substantial empirical evidence has confirmed that the rapid rise in interest rates in the United States and the Eurozone between March 2022 and July 2023 has exerted a detrimental effect on the economic welfare of many EMDEs. This has occurred mainly because of the associated strengthening of the US dollar, which has aggravated public finance stress via rising bond yields and depreciating currencies in developing countries.
Several empirical studies covering a wide spectrum of EMDEs have confirmed that high interest rates are detrimental to capital formation and economic growth. A common conclusion was that high interest rates restrict the ability of developing economies to sustain their respective transitional levels due to inadequate rates of economic growth.
A higher passthrough of cost shocks to inflation exists in EMDEs, as they feed through much more into inflation expectations as well as through other channels such as de facto wage indexation. In particular, oil price shocks tend to impact core inflation more than twice as strongly in a sample of EMDEs, relative to post-industrial economies.
The policy option of substantial fiscal stimulus to alleviate the economic downturn during the Covid-19 pandemic was never available in any of the EMDEs, which prevented them from countering the negative impact of job losses and declining private consumption expenditure levels. By raising interest rates to their highest level in 15 years, the MPC aggravated the slump in demand, which ultimately led to GDP growth of merely 0.5% in 2024.
Subsequent to the latest global experiment with attempting to combat supply-side inflation with higher interest rates, empirical research has confirmed significant negative side effects of interest rate hikes in EMDEs. These include the aggravation of cost pressures on the supply-side (due to lower capacity utilisation in the manufacturing sectors) and increasing the risk of insufficient investment in new productive capacity.
Several theoretical explanations underpin the necessity of caution when interest rate increases are utilised for purposes of curbing inflation, especially in the absence of excess demand in the economy and where temporary supply shocks are responsible for higher price levels. Monetary policy affects financial conditions and asset prices, by driving changes to market liquidity and by influencing the extent of credit rationing or availability. Ultimately, price shocks as occurred in 2020 and 2021, are amplified by higher interest rates.
Due concern has been raised over the destabilising effect of high interest rates on banks and the capital market, especially as a result of recent bank failures in the US and Switzerland. Two of the mechanisms that existed during the 2008 global financial crisis remain prevalent, namely a large number of banks around the world that have a large exposure to US securities and the increase in leverage, that has led to financial institutions financing their portfolios with less and less capital.
A dire situation has developed since 2020 for the level of public debt in EMDEs, with nine different sovereigns having defaulted recently. According to a special report published by Fitch Ratings, the average emerging market sovereign rating has recently fallen to an all-time low. Although high interest rates have assisted external sovereign bonds in becoming the best performing asset class over most of the past three decades, these high investor returns equate to high borrowing costs for developing countries, thus diverting government expenditures to the servicing of debt.
Various empirical studies have suggested that emerging markets should strive for an inflation target threshold that is higher than those encountered in AEs, whilst also requiring a degree of flexibility. The policy implication of these findings is that the Reserve Bank should consider revising its current inflation target upwards, as it is too low and too narrow for an emerging market economy.
Employment creation is widely regarded as one of the most powerful instruments for reducing poverty and improving the quality of life, especially in developing countries. According to research by the United Nations, employment-led growth can generate virtuous circles of prosperity and opportunity. High interest rates act as a barrier to the ability of the private sector, especially small businesses, to secure the working capital required for investment in new productive capacity and, as an inference, on the ability to create jobs.
Most empirical findings on the impact of interest rates on income redistribution point to the conclusion that contractionary monetary policy increases income inequality, which points to long-run distributional consequences, since the impact of changes in interest rates do not net out over the business cycle.
Various economic research studies have emphasised the benefits of tolerating a relatively mild rate of inflation in the economy. In its simplest form, the growth effect of demand via the Thirlwall model implies that the growth rate of supply is endogenous to dynamic economies of scale from a faster rate of capital accumulation, embodied technical progress and learning-by-doing effects. The results of some element of demand inflation and relatively benign lending rates are that real wages do not necessarily decline. Another benefit of a modest money-financed fiscal deficit is the reduction in the cost of borrowing through lower real interest rates, which then act as stimulus to capital formation.
Although the practice amongst central banks to set numerical targets for the desired level of price stability, known as inflation targeting, has been around for several decades, most EMDEs have preferred to steer away from a rigid policy approach, due to the existence of profound pitfalls for economies with relatively small output levels and that are heavily dependent on international trade. Recent empirical studies have concluded that, while numerical targets in AEs have become stricter (e.g. target points rather than ranges), greater flexibility has taken the form of less strict or longer horizons to achieve the targets and also greater weight on other economic policy objectives, especially employment creation and economic growth.
Several economists have questioned the role of inflation targeting in the face of recurring asset bubbles and supply side shocks, most notably Jeffrey Frankel, Olivier Blanchard, Paul Krugman, Anton Korinek and Joseph Stiglitz. According to Frankel’s research, nominal GDP targeting, unlike inflation targeting, would avoid the problem of excessive monetary tightening in response to adverse supply shocks. Nominal GDP targeting, with an element of flexibility, would assist in stabilising demand when supply shocks occur, which would also prevent the possibility of stagflation.
Section B
A notable shift towards growth-inhibiting monetary policy became evident from 2015 onwards, which became excessively restrictive soon after the worst of the Covid-19 pandemic. The negative macro-economic impact of the record high interest rates that accompanied this policy shift is both pervasive and alarming. Key conclusions drawn from a thorough analysis of the damage inflicted on the economy are:
The quarterly Afrimat Construction Index (ACI), which captures ten key indicators of economic conditions in the construction sector, including employment, production of building materials, value added in construction and hardware sales, went from lethargic growth between 2011 and 2019 to a pronounced decline since mid-2022, when the high cost of capital formation eventually forced the index value to below the 2011 base period level of 100.
Following the recovery from the global financial crisis in 2009, construction works by the public corporations and general government resumed a growth path, with a real increase of more than 18% between 2011 and 2015. Unfortunately, a combination of corporate government failures and higher interest rates then resulted in a decline in the real value of public sector construction works of 41% between 2015 and 2019. Since then, the unwarranted record high cost of capital has led to a further decline of 21%. For a country with glaringly obvious infrastructure deficiencies, it is nothing short of a disaster that the real value of construction works by the public sector has more than halved since 2015 – when monetary policy started becoming more restrictive.
The debilitating effect of unduly restrictive monetary policy since especially 2021 has resulted in declines in the real value of building plans passed in KwaZulu/Natal, Gauteng and the Western Cape of 71%, 69% and 59%, respectively, over the past four years.
Construction is the most labour-intensive sector in the economy, and the restrictive monetary policy of the Reserve Bank has not only prevented this sector from recovering from the Covid pandemic but has directly contributed to the sector entering a serious recession.
An inverse correlation exists between the level of mortgage bond interest rates and the number of home loan applications by prospective home buyers. Following the sustained rate-hiking cycle by the MPC, the BetterBond Index of Home Loan Applications declined by 29% to a low during the fourth quarter of 2023. Since then, due to marginal interest rate relief, this Index has started to recover, but it remained 21% lower in the third quarter of 2025 than during the third quarter of 2021.
Since the 1st quarter of 2022, when the restrictive monetary policy of the SARB kicked in, the average house price for first-time buyers whose mortgage bonds are administered by BetterBond has declined by 8.6% in real terms. The negative effect on house prices due to the relentless rise in interest rates has impacted on every age group of home-buyers.
Between the third quarter of 2021 and the second quarter of 2024, a distinct inverse relationship developed between average salaries in the formal sectors (at constant prices) and the prime lending rate (based on four-quarter average salaries, in order to eliminate seasonal influences). During this period, the average real salary in the formal sectors of the economy declined by 2.5%.
According to National Treasury, the small business sector is responsible for more than half of the country’s total employment and GDP. Unfortunately, the high level of commercial lending rates since 2022 has resulted in a majority of businesses in this crucially important sector being in a state of contraction, difficulty, or risk of closure (according to the Absa/SACCI Small Business Growth Index – researched by Unisa’s Bureau of Market Research).
A sharp increase occurred since 2022 in household debt servicing costs, with households spending 33% more of their disposable incomes on interest costs in 2025 than three-and-a-half years ago. It has become clear that the standard of living of South African households will not be lifted unless interest rates decline to substantially lower levels.
The inferior GDP growth performance of South Africa, relative to its peers in the EMDEs, has worsened significantly since 2022, when domestic interest rates were raised to a 15-year high, despite the absence of any sign of demand inflation.
Empirical research confirms that restrictive monetary policies contribute to an increase in income inequality, especially due to slowing down the rate of employment creation.
Since 2022, higher interest rates have resulted in lowering demand for local manufactured goods, thereby leading to a decline in capacity utilisation in South Africa’s factories. The MPC’s restrictive monetary policy has therefore contributed to an increase in the fixed costs per unit of production, thereby aggravating supply-side inflation.
It is a serious indictment of South Africa’s macroeconomic policies over the past decade that capital formation has been neglected to the extent that it comprised less than 15% of GDP in 2024, due, inter alia, to overly restrictive monetary policy and high interest rates. This figure is less than half of the ratio that existed in India and South Korea and 55% lower than the global average of 25.9%. In the absence of a sufficient expansion of productive capital, an economy’s future growth potential is seriously compromised.
When the cost of investing in new productive capacity becomes too high (as is the case in South Africa), it acts as an effective tax on venture capital. This is due to the ease with which income can be earned by rather investing surplus funds (that could have been earmarked for the expansion of productive capacity) into financial instruments such as money market accounts.
The unwarranted increase of more than 100% in annual average real lending rates between 2021 and 2025 has exerted a profound stifling effect on household consumption expenditure and new investment in productive capacity by the private sector, which are the main engines for demand-led economic growth in South Africa.
Since 2011, a clear inverse correlation has been observed between the rising cost of credit and the ratio of household credit extension to GDP. During mid-2025, the real value of total household credit in South Africa was 8.3% lower than in 2012. Furthermore, South Africa’s ratio of domestic credit extension to GDP is low by international standards. According to IMF data it was 90% in 2024, compared to a world average of 146%.
The real disposable incomes of South African households have declined consistently over the past decade, with a more pronounced downward trend line since the restrictive monetary policy started to take its toll on virtually all of the country’s key indicators of economic activity. The consistent erosion of the financial disposition of South African households since the new monetary policy regime took over in 2015 should be a point of huge concern to the government, as this issue was in all likelihood at play during the national elections of 2024 and will probably feature again in upcoming elections.
Over the past decade, it has become apparent that the SARB’s policy focus has been concentrated on the lowering of inflation, with a disregard for the second element, namely, to conduct policy in the interests of balanced and sustainable economic growth (as per its Constitutional mandate).
The policy objective of meaningful employment creation (which is inherent in attempting to foster sustainable high levels of economic growth) has been neglected to the extent that the number of formally employed people in South Africa now equates to the number of unemployed people, namely just over 11.5 million. Following a decline in unemployment levels shortly after the relatively low-interest rate environment of 2021 and the beginning of 2022, unemployment started to increase again as GDP growth started dropping to close to zero in 2024.
An inverse correlation between the formal employment coefficient and the real prime lending rate has been observed since 2012 (utilising logarithmic trend lines). An inverse correlation between the real prime rate and the year-on-year percentage change in private sector employment has also been observed since the end of 2021.
South Africa has the highest unemployment rate of the group of 26 EMDEs included in the MSCI emerging markets indices. At 33.2% (narrow definition), South Africa’s unemployment rate was almost six times higher than the EMDE average for 2024.
A World Bank report was commissioned by the South African government in 2023 and completed in 2025, titled Driving inclusive growth in South Africa. The report identifies a number of priority areas for feasible, impactful and timely policy actions to correct the country’s growth trajectory, most of which can only be successful with the maximum involvement of the private sector, especially in the areas of construction and transport logistics, which require substantial amounts of financial capital. Current commercial lending rates are not conducive to the attraction of such capital or to the venture capital requirements for stimulating small business activity recommended in the report.
Section C
As discussed in some detail in sections one and two, interest rate changes have exerted a profound negative impact on the South African economy since 2022, which could well have been avoided. In order to fully understand the extent of the damage inflicted on the economy by unduly high interest rates, an econometric impact assessment was conducted via a scenario with a modestly lower interest rate trajectory between the second quarter of 2022 and the first quarter of 2025.
An autoregressive distributed lag model (ARDL) was fitted according to the variables, regressors and other specifications discussed in section C. The adjusted R-squared was determined as 0.9989, which means the explanatory variables explain more than 99% of the variance in GDP and the F=statistics also confirm the joint significance of the explanatory variables.
The modelling results show that GDP would have been higher in all quarters after the second quarter of 2022 as a result of a modestly lower interest rate trajectory, ending with a 2.8% higher GDP than the actual for the first quarter of 2025. This translates into a value increase in GDP of R206.4 billion, which would have led to higher employment and also increased fiscal revenues.
Section D
In addition to quantifying the negative effect of unduly high interest rates experienced since 2023 by means of econometric modelling, evidence is provided evidence via a second method, based on two realistic alternative values for the average ratio of household debt costs to disposable incomes over the period 2023 to the first quarter of 2025.
The differences between these values and the actual values (which were considerably higher as a result of the record high interest rates) were then utilised to calculate the values for disposable incomes that would have materialised in the presence of a more accommodating monetary policy stance during the relevant quarters. Under the realistic assumption of a unitary marginal consumption propensity, the latest input/output table multipliers before the Covid-19 pandemic were then applied to these calculations to quantify the values for GDP; employment; and taxation revenues that were foregone as a result of unwarranted restrictive monetary policy, yielding the results in the following table:
Recommendations
This study has provided ample proof of the debilitating effects exerted on South Africa’s economy by a monetary policy approach that has been pursued at the cost of GDP growth, employment creation, poverty alleviation and lower inequality. The most important objective of macroeconomic policy for an EMDE like South Africa should be to grow the economy at rates that are conducive to lowering the country’s unemployment rate and generating sufficient fiscal revenues to maintain spending on the social wage and expanding infrastructure.
With almost 50% of the country’s labour force not able to find employment and the GDP growth rate remaining at marginally above zero, the threats to fiscal and social stability in South Africa are glaringly obvious.
In light of the multi-faceted and pervasive nature of damages inflicted on the economy since especially 2023, the following recommendations require serious consideration by National Treasury, which is the ultimate custodian of appropriate macroeconomic policy formulation in South Africa:
The composition of the Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) should be amended to become more inclusive and democratic, as any decisions on interest rates has profound direct and indirect effects on the well-being of households. It is recommended that the MPC should consist of twelve members - two persons from each of the following six institutions/organisations:
The SARB
National Treasury (the Director-general and Chief Economist - ex-officio)
Parliament (from the relevant Standing Committee/s)
The banking, investment and financial services sector
Key employer organisations (such as the Minerals Council, Consulting Engineers SA; Business Unity SA)
Key trade unions
Each of these MPC members should possess at least 20 years’ experience in macroeconomic research and a minimum qualification of a master’s degree in economics. The final decision on the selection of MPC members should be the responsibility of the Minister of Finance, for approval by the Cabinet.
In the interim, the MPC should consider lowering the repo rate to a level that allows the benchmark commercial lending rate (the prime overdraft rate) to approximate the same real level (adjusted for the CPI) that existed between 2011 and 2015, namely between 3% to 5% (when the average annual real GDP growth rate was 2.4% and 2.37 million jobs were created).
The decision to substitute the long-standing inflation target range of 3% to 6% by a target point of 3% should be reversed. A lower inflation target will eventually imply a relatively higher interest rate environment, which will continue to hurt the poor via continued lethargy in GDP growth and employment creation. It will also threaten fiscal stability and serve to aggravate income inequality.
Postscript
Graham Barr and Brian Kantor (2023):
By raising the interest rate by 50 basis points on May 25, the central bank has done little except inflict damage on an already weak South African economy. Restrictive monetary policy has clearly hurt, not helped, the exchange value of the rand by directly depressing any growth prospects for the economy, achieving precisely the opposite of what one assumes was intended.
Joseph Stiglitz (2022):
There is an absolute necessity for deep interest rate cuts for the national economy to thwart an impending recession. South Africa's reliance on inflation targeting can be problematic given its high levels of unemployment and the impact of a strong exchange rate on its competitiveness. A balance is required between inflation concerns and other critical economic goals, such as job creation and economic growth. Policies aimed at stimulating growth and reducing unemployment should be given greater weight, especially during economic downturns.
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This report has been published by the Inclusive Society Institute
The Inclusive Society Institute (ISI) is an autonomous and independent institution that functions independently from any other entity. It is founded for the purpose of supporting and further deepening multi-party democracy. The ISI’s work is motivated by its desire to achieve non-racialism, non-sexism, social justice and cohesion, economic development and equality in South Africa, through a value system that embodies the social and national democratic principles associated with a developmental state. It recognises that a well-functioning democracy requires well-functioning political formations that are suitably equipped and capacitated. It further acknowledges that South Africa is inextricably linked to the ever transforming and interdependent global world, which necessitates international and multilateral cooperation. As such, the ISI also seeks to achieve its ideals at a global level through cooperation with like-minded parties and organs of civil society who share its basic values. In South Africa, ISI’s ideological positioning is aligned with that of the current ruling party and others in broader society with similar ideals.
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