Digitalisation helps improve monetary policy transmission: RBI

Transmission of policy rates could be more effective in a digitalised scenario as it could help in steeper reduction in inflation according to the Reserve Bank’s latest Report on Currency and Finance.A study published in the report explains various scenarios in which a unit repo rate hike on inflation. In a baseline scenario a 100 basis point (bps one bps is 0.01 percent) rise in the policy rate leads to a fall in output and inflation by 40 bps and 25 bps, respectively. But in the scenario of digitalisation on the other hand, on account of an improving factor productivity, the effect of monetary tightening on output remains the same while that on inflation is lower at 20 bps.

If digitalisation were to lead to a decline in resistance to price change by 10%, say, due to the rising online presence of retail stores and dynamic pricing algorithm, inflation fall could be higher at 35 bps without impacting the output in the economy. If the price elasticity of demand falls, inflation could drop by 30 bps (5 bps more than its baseline level), the study explains.

The report also highlights the number of ways digitalisation helps in monetary policy transmission. Digital financial system can automatically adjust interest rates on deposits and loans in response to policy rate changes, potentially accelerating the transmission of monetary policy, RBI said.

Digitalisation influences the nature, composition, and behaviour of money in the economy, with ramifications for monetary aggregates and monetary policy transmission.

Enhanced liquidity through financial innovation facilitates more effective transmission of monetary policy. Besides, digitalisation can improve access to financial services and enhanced financial inclusion is found to improve the transmission of interest rate-based monetary policy impulses.Conceptually, CBDCs can induce changes in public’s demand for currency; banking system deposits and credit; retail, wholesale and cross-border payments; and monetary policy implementation and transmission.Given that digitalisation can impact inflation and output dynamics, and monetary policy transmission in diverse manners and the overall impact could vary over time given the fast pace of developments, the report suggests that central banks would need to incorporate digitalisation aspects comprehensively into their models for the continued efficacy of monetary policy and the achievement of their price and financial stability goals.