RBI report reveals impact of digitalization on price elasticity and inflation

The Reserve Bank of India (RBI) has released a comprehensive report on currencies and finance, detailing the profound impact of digitalization on the price level through direct and indirect channels. The report highlights how digital technologies are changing production and consumption behavior, thereby affecting market competition and price elasticity.

According to the report, digitalization is directly contributing to lower inflation rates by reducing the prices of ICT-related goods. This trend, seen post-pandemic, extends to both hardware and software prices in India. Indirectly, digitalization is changing firms’ pricing behavior and market dynamics, with new e-commerce players driving increased competition.

In addition, digitalization reduces menu costs by enabling price changes without the significant expense of reprinting price tags or restructuring pricing strategies. RBI notes that dynamic pricing becomes feasible by making prices more responsive to economic changes by reducing menu costs, improving access to information and increasing the flexibility of price updates.

The report cites frequent price changes for vegetables and groceries on online platforms, contrasting with less frequent changes offline. As internet penetration increases, digital retail shopping and the number of online shoppers will increase, driving down prices by reducing the costs of search, replication, transportation and verification.

This increase in digital engagement increases price and information transparency, potentially putting downward pressure on prices. In addition, digitalization improves access to financial services, and greater financial integration increases the effectiveness of interest-based monetary policy in containing inflation.

Research suggests that monetary policy can be more effective at reducing inflation in a digital context. The primary objective of monetary policy, managing inflation, can have significant effects due to the impact of digitalization on information costs, as tools such as search engines and e-commerce platforms drastically reduce the costs associated with gathering information and comparing prices.

These advances can strengthen the effectiveness of monetary policy in maintaining price stability. However, reducing price stickiness can reduce the effectiveness of monetary policy. Central banks must therefore comprehensively incorporate digitalization into their models to maintain effective monetary policy and achieve price and financial stability.

(Based on information from the agency.)