“The euro belongs to Europeans and we are its guardian. We should be prepared to issue a digital euro, should the need arise.” (Christine Lagarde, 2020)
The European Central Bank (ECB) provides currency in two forms: it issues banknotes and it transfers electronic deposits to banks and other financial institutions. A digital euro would be an electronic form of central bank money accessible to all citizens and firms – like banknotes but in a digital form. It is not meant to replace cash, but rather to complement it. The ECB recently made first steps towards committing some of its 11 billion EUR capital to a digital euro, publishing a report and entering into dialogue with representatives from the payments industry in October 2020. It will decide whether to introduce the digital Euro in mid 2021.
However, the introduction of a digital euro could affect the transmission of monetary policy and have a negative impact on financial stability, for example by challenging banks’ intermediation capacity and by affecting risk-free interest rates. Depending on its characteristics as a form of investment, it might induce depositors to transform their commercial bank deposits into central bank liabilities. This might increase the funding costs of banks and, as a consequence, interest rates on bank loans, potentially curtailing the volume of bank credit to the economy.
A digital Euro might also impact the profitability and risk-taking of the central bank: The issuance of a digital euro would change the composition and most likely the size of the Eurosystem’s balance sheet, and would therefore affect its profitability and risk exposure. Issuing money is normally profitable and generates seigniorage income because of the difference between the remuneration of central bank assets and the interest rate applied to central bank liabilities (the rate is zero for banknotes).
Yet in a technologically adaptive economic ecosystem, the Eurosystem could benefit from a digital Euro in the following future scenarios:
Scenario 1: the digitalisation and independence of the European economy can benefit from a digital form of central bank money available to citizens.
Scenario 2: the role of cash as a means of payment declines significantly.
Scenario 3: a form of money other than euro-denominated central bank money, commercial bank deposits or electronic money becomes a credible alternative as a medium of exchange and, potentially, as a store of value in the euro area.
Scenario 4: if the Eurosystem were to conclude in the future that the issuance of a digital euro is necessary or beneficial from a monetary policy perspective.
Scenario 5: there is a need to mitigate the probability that a cyber incident, natural disaster, pandemic or other extreme events could hinder the provision of payment services.
In conclusion, in a range of future scenarios, a digital euro could be a viable option for the 11 billion EUR ECB and the Eurosystem in order to achieve the objectives related to core central bank functions. Given these scenarios, the benefits are expected to outweigh the risks of higher interest on bank loans and smaller credit volume to the economy.
By Lukas Wittman
Sector Head: Jackson Philips