CHRISTINE LAGARDE

WANTS A DIGITAL EURO

COPENHAGEN ECONOMICS

Authors Antti Lemberg Jens Brink 07 April 2021

A digital Euro may very well be on the way, allowing Europeans to conduct direct payments with a digital currency issued by a . Without digital currencies, it could prove difficult for central banks to navigate a world char- acterised by declining cash usage, the emergence of decentralised currencies and the potential threat these issues pose to monetary sovereignty in the long term. While this change will take the form of a natural evolution rather than a stirring revolution, it may still have an impact on commercial banks, and in turn, the real economy.

In October 2020, the published In a recent interview, Christine Lagarde, president of their first major report outlining the possibility of a dig- the European Central Bank, stated that “those who want ital euro. In early 2021, following a public consultation to use digital payment should be able to do so”, and that on the subject, the and the Eu- this may already be possible within the next four years2. ropean Central Bank officially intensified their joint re- search work on the matter1. By mid-2021, the Governing Council of the European Central Bank is expected to make the decision on whether to initialise formal devel- We need to make sure that our opment of a digital currency for Europe, formally known currency is fit for the future. as a “European Central Bank Digital Currency”, or Inaction is not an option. CBDC, as this form of tender is often referred to as. - on ECB’s webpage on digital Euro 3

While the debate on implementing a digital Euro is still ongoing, an ever-increasing body of evidence indicates Like Lagarde and a range of other senior ECB staff, Fa- that it is only a matter of time before it happens. bio Panetta, a member of the body which is expected to

1 https://www.ecb.europa.eu/paym/intro/news/html/ecb.mip- 2 https://www.youtube.com/watch?v=8EYnsgaJo8A news210119.en.html 3 https://www.ecb.europa.eu/euro/digital_euro/html/index.en.html

make the call on a digital Euro, the ECB’s Governing THE EU PRIORITISES PRIVACY, SECURITY Board, has publicly expressed the need for rethinking AND EFFICIENCY IN A DIGITAL CURRENCY the Euro in a digital world. None of these statements are As commercial banks already fill the need of conducting concrete evidence that the ECB will launch a digital digital monetary transfers, the immediate impact of a Euro, but the current consensus is that there is a gener- European CBDC will be limited. Still, though, ECB and ally favourable view towards some form of European the European Commission name a few key reasons to CBDC. prioritise the issuance. For one, a CBDC may help en- sure that users are able to remain anonymous, or at least DIGITALISING THE EURO WILL NOT private, when making a digital transfer of money in the REVOLUTIONISE IT same manner as how a cash transfer is private. Sec- The digital Euro will supplement the current monetary ondly, by introducing a CBDC, users do not have to rely system in the Economic and Monetary Union, not re- on the digital infrastructure of private banks to transfer place it. Issuing a digital euro will essentially increase money and may thus be less vulnerable to security the existing ways of conducting a payment in central breaches and downtime. bank Euro from two (Euro coins and Euro notes) to three: coins, notes, and digital Euro. Thus, a digital Euro Finally, being by default centralised, a CBDC may be will be a special case of M0-money, expanding the more efficient than current monetary systems. Indeed, money base directly, exactly as minting fresh Euro coins a digital currency will be easier to manage than printing does. The digital Euro will also share value and all de- and minting physical cash, and having one central solu- fining features with the existing cash-versions of the tion for the digital storage and transfer of money may currency. The innovation lies in the option to conduct a also reduce the need for the commercial banks to oper- digital monetary transfer using central bank money. ate and maintain their individual systems.

The digital transfer of money is of course not new. This Introducing a digital currency is not without its risks, has been possible through commercial banks for dec- however, with the most obvious being the effect on fi- ades. However, as of today, any digital transfer of money nancial stability. If a CBDC allows users to easily and relies on systems owned and operated by commercial conveniently hold money digitally with a claim on a cen- banks, and any Euro stored electronically is done so in tral bank, rather than on a commercial bank, users may a bank account and, ultimately, on the balance sheet of abandon commercial banks completely. This would fun- the bank. This form of existing electronic money is thus damentally change the banking landscape and have a claim on a commercial bank, unlike physical cash, enormous consequences for the financial system, im- which is a claim on a central bank. With a European pacting everything from issuing mortgages to ensuring CBDC, it would become possible to hold Euro digitally, international settlements, thereby halting economic ac- but with a claim on a central bank. tivity. If not done extremely cautiously, a CBDC could have large, adverse effects on the real economy.

BITCOIN AND OTHER CRYPTOCURRENCIES ARE FUNDAMENTALLY DIFFERENT FROM CBDC The difference between decentralised cryptocurrencies, such as Bitcoin, Ethereum and Ripple, and CBDC is the backing of a central bank. CBDC is a digitalisation of traditional central bank money and, as the issuer, a central bank will guarantee the value of a CBDC. Cryptocurrencies generally do not have any governing entity, backing or underlying value, meaning that the value of crypto assets is determined solely by market participants, similar to how price formations occur within commodity trading. This is among the reasons why cryptocurrencies historically have been subject to extremely high volatility, as compared to traditional currencies.

As such, there is a clear and fundamental distinction between CBDC and cryptocurrencies as concepts. Where they may over- lap, however, is in technology. A number of CBDCs in development, such as the Swedish e-krona and the Chinese DC/EP, are based fully or partly on distributed ledger technology, a concept first applied to facilitate payments with the introduction of Bitcoin. The reason why central banks are increasingly embracing distributed ledgers is the transparency and efficiency this technology provides. There is no inherent link between cryptocurrencies and CBDC, however, and a CBDC may just as well be built with traditional technology, such as a centralised database.

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ISSUING A CBDC MAY REALLY BE ABOUT IN A CASHLESS SOCIETY, CBDCS COULD MONETARY SOVEREIGNTY LEAD TO A NEW PARADIGM OF CENTRAL A CBDC is a high-priority research area in most central BANKING banks, including the ECB, the FED, and the Bank of In the event that issuing CBDCs becomes mainstream England. Much of this effort was prompted by the Face- among central banks, it could initiate a new era of mon- book-led initiative Diem4, which commenced in June etary policy, perhaps with the central banks placed 2019 with the aim of constructing a globally connected much closer to the people. While it undoubtedly will and user-friendly means of payment. One member of take a while before we get there, completely digitalising ECB’s Executive Board at the time, Benoît Cœuré, called money can potentially impact the economy and the role Diem a “wakeup call” for central banks, and agitated for of the central bank as we know it. the development of CBDC’s, stressing the risk of losing sovereign power over payment systems if private com- If and when cash disappears, either by a conscious deci- panies started running them5. sion from the central banks, or simply as it becomes ir- relevant and is left unused, having a CBDC may give This is also the concern of Sveriges Riksbank. The Swe- central banks a completely new set of digital tools to en- dish Central Bank is one of the most pro-active central sure financial stability. The most obvious of these would banks in the western world when it comes to digital cur- be the option to force negative interest rates. Without rencies. The country, in which less than 10% of citizens physical cash as a nominal store of value, there is noth- used cash for their latest purchase when surveyed in ing stopping major central banks from enforcing nega- 20206, are currently over a year into in the process of tive interest rates in the economy in order to stimulate testing a pilot-project of their CBDC, the e-krona. The economic activity, bringing forward the formal death of main driver is the fear that, as traditional cash goes out the zero lower bound. Having a CBDC is not a prerequi- of favour, Swedes will be left without access to central- site for this, but it would arguably make it easier for cen- bank-issued money and only be able to access electronic tral banks to control the money supply. krona in their commercial bank account. It need not to stop there, though: with digital advance- If this is the case, part of the incentive to hold domestic ments, a centralised digital currency which the central currency, the claim on and backing of the central bank, bank has full control over, and no safe option of storing may disappear, ultimately meaning that there may be nominal value, central banking can innovate. One, al- no mechanism guaranteeing that Swedes continue hold- beit extreme, example of such innovation would be the ing krona in their accounts. Indeed, in a globalised introduction of conditional stimulus checks. Imagine a world, it may be more convenient to hold other curren- scenario where the central bank deposits money directly cies, such as the US Dollar, Facebook’s Diem or even into your account, but the funds have a condition at- crypto assets such as Bitcoin. Should this happen, Swe- tached stating that you must spend the full amount on den risk losing sovereignty over the monetary system. goods or services from a small- or medium-sized busi- This will, among other potential problems, render Swe- ness and, if you do not, the money vanishes from your den unable to conduct monetary policy , and it is exactly account by the end of the year. Such concepts could this worry which is fuelling the intensification of Sveri- prove very useful in a future economic crisis caused by, ges Riksbank work on introducing a CBDC7. say, another pandemic.

4 The Diem project was originally known as Libra 6 https://www.riksbank.se/en-gb/payments--cash/payments-in-swe- 5 https://www.ecb.europa.eu/press/key/date/2019/html/ den/payments-in-sweden-2020/1.-the-payment-market-is-being-digi- ecb.sp190925~3afa2f7508.en.html talised/cash-is-losing-ground/ 7 https://www.bis.org/review/r180123c.pdf

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Hard facts. Clear stories.

Antti Lemberg leads CE’s financial services work. He has 20 years of experience in advising banks, insurers, trade associations, regulators and government departments on financial services policy and regulation in Europe, Asia, Africa and South America.

Contact information: [email protected]

Jens Brink is an expert on financial services regulation and policy who has supported many of our recent engagements with financial services clients.

Contact information: [email protected]

About Copenhagen Economics

Copenhagen Economics is one of the leading economics firms in Europe. Founded in 2000, the company cur- rently employs more than 90 staff operating from our offices in Copenhagen, Stockholm, Helsinki, and Brussels. The Global Competition Review (GCR) has listed Copenhagen Economics among the Top-20 economic con- sultancies in the world since 2006.

www.copenhageneconomics.com 4