IMPACT OF TRADE OPENNESS ON INFLATION: EXPLORING THE ROLE OF DIGITALIZATION

Abstract

Many empirical studies have been conducted on the relationship between trade openness and inflation since Romer's hypothesis (1993). The current study examines the relationship between inflation and trade openness, as well as the threshold level of digitalization. The study uses balanced panel data from 1996 to 2023. It employs the system (GMM) method to determine the impact of trade openness on inflation and estimate the threshold level of digitalization for the heterogeneous income groups of countries. Previous research has shown both positive and negative relationships between inflation and trade openness in different countries, both individually and regionally, while other studies have focused solely on a panel of countries. The present study addresses the following gaps: firstly, the overall global impact on all income levels remains unexamined. Secondly, it examines the moderating role of digitalization, including identifying the threshold level of digitalization. The study's findings revealed that trade openness has a significant positive impact on inflation before including the interaction term. When trade openness interacts with digitalization, we observe both positive and negative results due to the threshold, despite the interaction term being significant and positive. Overall, the effect of trade openness on inflation remains negative in the presence of digitalization in our sample, indicating that the level of digitalization in our dataset is below the threshold (47.8%). Therefore, trade openness continues to have a deflationary effect. Policymakers should promote productivity, price transparency, and supply chain efficiency to help lower inflation. They should also consider the level of digitalization when designing targeted policies to manage trade openness on inflation.