Behind the ECB’s Digital Currency Push

Macroeconomics

BehindtheECB’sDigitalCurrencyPush

By Katharine Neiss, PhD — Nov 4, 2021

5 mins

When Facebook announced its plan to launch Libra in 2019, the news caused a collective outcry from central banks and finance ministers around the globe. Officials were concerned that stablecoins¹ would pose a threat to global financial stability and weaken the transmission mechanism of monetary policies, ultimately undermining the sovereignty of nation states. While Facebook’s project has since been dramatically scaled back, the announcement served not only as a turning point for regulators, who quickly realized stablecoins need to “do no harm,” but it also accelerated central banks’ efforts to understand the costs and benefits of issuing a digital version of their own currency.

As these efforts have gathered pace, with more than 80 central banks around the world researching central bank digital currencies (CBDCs), the European Central Bank (ECB) – along with other major central banks such as the People’s Bank of China – has moved to the forefront by formally launching an investigation phase of a digital euro.² Whatever the outcome, the process will likely take four to five years, as central banks have to catch up with the fastmoving technology of launching a digital currency, demonstrate due diligence to maintain trust, and ensure the public is adequately consulted.³ This blog considers the potential implications of a digital euro: is it an evolution of money? Or much ado about nothing?

Why Have a Digital Euro?

Currently, money issued directly by central banks can only be electronically accessed by a select group of banks and financial institutions. A digital euro would allow everyone—including households and businesses—to directly make electronic payments in money issued by the ECB. The ECB has a unique role as lender of last resort, which underpins the stability of its currency and delivers a store of value function – no privately issued currency, digital or otherwise, has a comparative advantage over the central bank given this unique function. Therefore, a key distinguishing feature of a digital euro is that it would be a type of stablecoin whose value is backed by the central bank, thereby guaranteeing its stability against the euro.

Features of a Digital Euro

Policymakers are concerned by the rise of cryptocurrencies as they could severely disrupt the functioning of financial markets and lead to financial stability risk. Having a payment system that is detached from the traditional plumbing of the financial system may also dilute the effectiveness of policy tools, since monetary policies hinge on financial intermediaries, mainly banks, to transmit policies to the real economy.⁴ The latter risk has undoubtedly raised alarm bells, particularly in Europe, given the existing concerns around the health of the overall banking sector and the crucial role that the banking system plays in supporting the real economy. Against that backdrop, some broad contours of a digital euro have begun to emerge, as summarized in Figure 1.⁵ These key features aim to secure the central bank’s role as the provider of money as a public good and ensure the digital euro is a competitive alternative to a decentralized, token-based digital currency. Taken together, the digital euro would be focused primarily on improving payment services to consumers – by offering greater efficiency, lower costs, and broader access to financial services.

Figure 1

Possible Features of a Digital Euro

Additional Benefits for Europe

In addition to the benefits described above, EU policymakers regard payment innovation as a means towards its goal of “strategic autonomy” by, for example, enabling a move away from non-European payment systems such as Visa and Mastercard. The shift toward non-cash payments is expected to continue, with more than 70% of euro area transactions by volume still conducted in cash, according to the ECB. Moreover, that shift is likely to accelerate given more than 80% of respondents to a recent survey indicate they will “certainly” or “probably” continue to use less cash following the pandemic (Figure 2).

Figure 2

ECB Survey

Policymakers also expect a digital euro will facilitate cross-border transactions within the euro area, helping to deepen financial integration, and improve the ease of conducting cross-border retail payments, including remittances. It could further underpin the free movement of labor, goods and services across Member States.

Conclusion

Efforts to introduce a central bank digital currency are gaining momentum in Europe, and we could we see a digital euro in four to five years, though remaining uncertainties suggest this is far from a done deal. Given the innovative nature of CBDCs, any prediction risks becoming a hostage to fortune. That said, since the Libra announcement, world leaders have come to an agreement that stablecoins should “do no harm.” It is now widely agreed that stablecoins should meet the same criteria and requirements as traditional payment, clearing and settlement systems, and there are legislations being discussed to fill the regulatory gaps. Central banks, such as the ECB, are in a unique position of trust to back a currency, provide liquidity, and act as lender of last resort. As such, we expect CBDCs to be designed as a complementary part of the existing financial infrastructure. However, it’s not a foregone conclusion that the digital euro will have an edge over other stablecoins. From an end-user perspective, the key determinant will likely be Europe’s ability to innovate and use the digital euro as a catalyst to revolutionise the European payments system, which will ultimately enhance the role of the euro and help overcome existing socioeconomic barriers.

¹A stablecoin is a privately issued digital currency whose value is backed up by a solid claim on assets, such as the U.S. dollar.

²Auer, Cornelli and Frost, ‘The rise of the central bank digital currencies: drivers, approaches and technologies’, BIS Working Paper, no 880, August 2020.

³The Eurosystem has emphasised that any decision to launch a digital euro will be made in close consultation with the European Parliament and within the legal framework of the Treaty on the Functioning of the European Union.

⁴See G7 Working Group on Stablecoins, Investigating the impact of global stablecoins, Oct 2019.

⁵See Coeuré, Sep 2021, Central bank digital currencies: the future starts today, and Binseil, Tiered CBDC and the financial system, ECB working paper no. 2351, Jan 2020.

By Katharine Neiss, PhDDeputy Head of Global Economics and Chief European Economist, PGIM Fixed Income

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