Do Internet-Driven Trade Shocks Moderate the Exchange Rate Pass-Through to Inflation?

Abstract

This study examines the existence of an internet globalisation intensifying impact on the size of the exchange rate pass-through (ERPT) to inflation, which conditions the response of central banks' policy rates. Expanding on the traditional determinants of ERPT, we incorporate technology-induced trade shocks linked to internet adoption to engage in the long-lasting debate on the effectiveness of monetary policy in a changing global environment. Using a fixed-effects moderated moderation model, we examine the joint impact of internet penetration, imports of goods and services, and the real effective exchange rate index on the marginal effect of inflation on policy interest rates. Using the Taylor rule as a benchmark, we conduct an empirical analysis on a panel of 15 inflation-targeting emerging economies over the period 2000–2020. The interaction effects among variables indicate: (1) the negative effect of exchange rate depreciation on inflation is amplified in economies with higher import shares; and (2) greater internet usage further intensifies this amplification. A central finding of this study suggests that internet-driven globalisation moderates the sensitivity of interest rates to inflation via its influence on the ERPT mechanism. This highlights the importance for policymakers to consider evolving global technological dynamics in the formulation of effective monetary policy.