Diffusion of the Internet and Low Inflation in the Information Economy

H.H.M. Meijers*

*Corresponding author for this work

Research output: Contribution to journalArticleAcademicpeer-review


The adherents of the so-called ‘new economy’ claim that we are entering a new era with high output growth, low unemployment and low inflation. Ict investments in general and the increased use of the internet play an important role in this claim. In the literature we find three different explanations for the low inflation experience. Increased productivity growth combined with sluggish adjustment of wages, improved credibility of monetary policy and improved functioning of the labour market. This paper provides another explanation where adoption of internet as a cost reducing and efficiency improving technology changes market structures and affects the mark-up margins of firms and thereby the relation between costs and output prices. The diffusion of the internet as a cost saving technology is introduced in a model with network effects and dynamic market structures. The latter two result in an endogenous diffusion process of the use of the internet for business-to-business commerce. However, there is also some feedback from the increased adoption of the internet. Diffusion also affects the market structure and therefore the gains of the efficiency improvements obtained by doing business via the internet. The combination of the diffusion of the internet, the characteristics of network effects and the dynamics of the markets can explain variation in the mark-up on production costs explains at least a part of the low inflation experience. However, the model also predicts that the inflation suppressing effect of the increased use of the internet eventually will cease and that inflation will increase in the longer run. The paper adds two new elements to the existing literature. First, it describes a model that combines network effects with changes in market structures to explain the diffusion of a cost reducing technology, i.e. The internet. Second, it uses this model to explain the current low-inflation experience.
Original languageEnglish
Pages (from-to)1-23
Number of pages23
JournalInformation Economics and Policy
Publication statusPublished - 1 Jan 2006


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