Bundesbank President Jens Weidmann used a speech at the annual meeting of the German Economic Association (Verein für Socialpolitik) in Freiburg to share his thoughts on how digitalisation might impact on monetary policy. He explained that digitalisation has the potential to influence productivity, employment and inflation, arguing that this may well shrink the room for monetary policy manoeuvre in future. “If digitalisation were to dampen inflation over a prolonged period of time, nominal interest rates would fall,” he remarked, and that would narrow the gap to the lower bound. “This increases the likelihood – all else being equal – of monetary policymakers having to resort to non-standard measures to remain capable of effective intervention.”

The downside to this would be that, in the new long-term equilibrium state, the potential for price cuts would already have been exhausted and the dampening impact on the rate of inflation would have ceased. Mr Weidmann went on to note that digitalisation could also produce countervailing effects. “If digitalisation brings increases in productivity and potential output growth, the natural rate of interest will rise,” he observed, arguing that this would “push up nominal interest rates, giving conventional monetary policy more room to play with”.

Innovation and competition

Turning his attention to the possible reasons why inflation is growing at a weaker rate due to digitalisation, Mr Weidmann noted that technological progress is pushing up productivity, driving down the costs of production. “Prices ought to follow costs downwards, assuming there is sufficient competition,” he reasoned. Another possible explanation is the increased price transparency brought about by online retailers and price comparison websites, which is intensifying competition and thus squeezing margins and prices. 

Besides exploring the dampening effects which digitalisation might have on prices, Mr Weidmann also touched upon factors which have the opposite effect. One such factor could be the rise of dominant “superstar” firms, such as online providers of information-based goods. Mr Weidmann explained that their business models tend to generate substantial one-off costs but barely any additional costs per user. Increasing returns to scale are also being generated in the social media or by peer-to-peer platforms, he observed, which is why “some companies often emerge as winners as time progresses.” These players “can then capitalise on the market power they gain to push up their prices and margins”.

Inflation and how to measure it

Mr Weidmann explained that the dampening effect of digitalisation on inflation has arguably been on the low side hitherto, but noted that the measurement of inflation is another area where the advent of digitalisation is making itself felt. Online retailers can alter their prices either at the push of a button or without human intervention using dynamic pricing algorithms. “But for statisticians, prices that change frequently and fluctuate strongly are something of a challenge,” Mr Weidmann told his audience. These days, it is not enough for them to survey the price of a product once a month. This, he concluded, is making the measurement of inflation a more time-consuming task. At the same time, he acknowledged that digitalisation is opening up new measurement capabilities such as web scraping, which is a statistical method used to automatically capture online prices. 

Expand digital infrastructure

The Bundesbank President also used his speech in Freiburg to discuss the kind of environment businesses need to leverage the potential offered by digitalisation. For example, many digital technologies require access to a fast internet connection. And Germany is lagging behind other industrialised countries in this respect. “In particular, the expansion of the fibre optic network is making only slow progress here in Germany,” he remarked, observing that just two per cent of broadband connections are based primarily on fibre optic lines and thus on the technology that makes particularly fast internet connections possible. By contrast, the OECD average is 26 per cent. “This makes it all the more important for Germany to forge ahead and vigorously expand its digital infrastructure,” Mr Weidmann concluded.