Raising Interest Rates Won't Stabilize African Inflation

CAMBRIDGE—African economies began this year facing no shortage of challenges, including lower global demand for their goods and services, unpredictable tariffs and other trade barriers, post-pandemic debt overhangs, structural unemployment, and large net financial outflows. Then the United States and Israel launched their war on Iran, throwing the Middle East into turmoil, halting traffic through the Strait of Hormuz, and compounding inflationary pressures. Now, inflation has reached double-digit rates in some African countries. But the traditional monetary-policy prescription—higher interest rates—will not work to contain it, and might even make matters worse.

To be sure, the International Monetary Fund has recommended monetary tightening, citing high public-debt levels, the risk of “procyclical spending surges” in oil-exporting economies, and the danger of overheating elsewhere. But this advice is analytically unsound, empirically flawed, and strategically dangerous. In fact, monetary tightening would amount to a demand-side remedy for a supply-side pathology.

Africa’s public debt did not arise from consumption. In most countries, fiscal and external deficits do not finance subsidies or excessive recurrent expenditure, but rather critical infrastructure needs and indispensable public services, such as hospitals and schools. These are assets with economic lives of 50 years or more, and productivity multipliers that standard—and short-sighted—debt-sustainability models underestimate.

Above-average growth in countries like Djibouti, Egypt, Guinea, Niger, Rwanda, Ethiopia, Morocco, Ivory Coast, and Tanzania reflects a supply-side expansion—in services, construction, and agriculture—not an unsustainable credit-fueled demand boom. Concerns about “overheating” are thus similarly misguided.

An economy overheats when demand for goods and services significantly outpaces the economy’s ability to supply them, and prices for labor and capital rise, generating demand-pull inflation, which interest-rate hikes can then dampen. But this framework applies in advanced economies with well-functioning labor markets, flexible wages, a capital stock operating near capacity, inflation expectations anchored by a credible central bank, and effective monetary-policy transmission mechanisms. None of these conditions holds for African economies.

Africa’s labor force is predominantly employed in subsistence and smallholder agriculture, the informal economy, and low-productivity services. Because agricultural labor markets are segmented, seasonal, and largely non-monetary in their clearing mechanisms, these sectors are not subject to the wage-setting dynamics that drive demand-pull inflation in industrialized economies. Wage pressure in the formal sector, which accounts for a small share of total employment, does not fuel economy-wide inflation.

Rising inflation in Africa is predominantly supply-side, cost-push, and structural in nature. As the IMF itself recognizes, it is driven by events beyond Africa’s control, which have raised the prices of goods African countries must buy from abroad, including fuel products, medicines, fertilizers, and food.

Standard macroeconomic theory holds that interest-rate increases work by raising borrowing costs (reducing investment and consumption, thereby cooling demand), tightening credit conditions (compressing spending), and strengthening the exchange rate (attracting capital inflows and lowering the cost of imports). In Africa today, none of these channels is particularly effective.

Start with borrowing costs. Higher interest rates cannot lower fuel or fertilizer prices, let alone resolve the conflict in the Middle East; they will have little impact on the informal urban sector and rural agriculture, which largely operate outside the formal banking system. This includes the smallholder farms providing the food that affects headline consumer price indices, and the informal food traders who set market prices for most African households.

What higher interest rates would do is raise the cost of credit for the small, formal, investable, growth-generating segments of the economy. This would undermine investment—including in critical sectors like energy generation and agro-processing—reducing productive capacity at precisely the moment when supply constraints are generating inflationary pressures.

The exchange-rate channel has some potential in the fight against inflation. But Africa’s capital accounts are often partly managed, and capital inflows arrive primarily in the form of foreign direct investment, not interest-rate-sensitive hot money. Moreover, domestic currency movements are determined more by structural trade deficits and global dollar dynamics than by marginal increases in central-bank rates.

A better strategy than monetary tightening would focus on accelerating the structural transformation that the continent badly needs, by channeling finance into productive and employment-creating industries.

To this end, African countries should establish or strengthen national development banks to provide long-term, below-market financing for strategic sectors and crowd in private investment. They should also use targeted credit allocation and refinancing facilities to direct lending toward priority sectors and mobilize domestic savings at scale through public-savings vehicles, sovereign funds, or development-finance institutions. Strict performance conditions and full transparency requirements should be attached to subsidized credit.

Export-credit institutions are also essential, with concessional finance and subsidies tied to measurable performance metrics, such as export targets, to instill discipline and prevent the financial system from succumbing to political patronage. As their economies mature, African countries should gradually recalibrate their financial toolkits, shifting from debt-heavy directed infrastructure credit to venture capital, equity participation, innovation finance, and regulatory sandboxes.

No economy has achieved structural transformation using textbook inflation-targeting and interest rates. Instead, success has depended on financial arrangements that solved coordination failures, financed long-term investment, and accelerated industrial upgrading. That approach, together with the diversification of food-production and energy systems, would go a long way toward strengthening Africa’s sovereignty, stability, and prosperity.

Célestin Monga, a former managing director at the United Nations Industrial Development Organization and a former senior economic adviser at the World Bank, teaches public policy and economics at Harvard Kennedy School. He is a former vice president and chief economist at the African Development Bank Group. He is the co-editor, (with Justin Yifu Lin) of The Oxford Handbook of Structural Transformation (Oxford University Press, 2019) and the co-author (with Justin Yifu Lin) of Beating the Odds: Jump-Starting Developing Countries (Princeton University Press, 2017).