Asymmetric threshold effects of digitization on inflation in emerging markets

This paper analyzes the dynamic asymmetric effects of digitization on domestic inflation for a sample of 54 advanced economies (AEs) and emerging markets (EMs) over the period 2004–2018. Using Katz and Calorda’s Digital Ecosystem Development Index and employing the system Generalized Method of Moments (GMM) estimation methodology, the results of the paper reveal that the improvement in digitization has a statistically significant nonlinear deflationary effect with an exact threshold level of 43.22 points, that is, that the marginal effect of the digital penetration is larger when its level is lower than the threshold level. For EMs, with a level of digitization below the average of our full sample, policymakers must continue to invest in and expand on their digital ecosystem until the threshold level is achieved. Our results show that investment in human capital and improvement in governance can reinforce these deflationary effects. Hence, to obtain the maximum positive impact of increasing digitization on domestic inflation, EM governments should focus on maximizing school enrollment, controlling corruption, establishing rule of law, protecting the right to freedom of opinion and expression, and implementing accountability measures.