Wednesday , January 22 2020

Time for e-Euro?

Summary:
I have just recently written for Moneycontrol on how European central bankers particularly French are really keen on introducing a central bank digital currency. Christine Lagarde (who is French!), recently appointed at helm of ECB in her first hearing at the European Parliament interestingly spoke on CBDC: The other topic you have asked me to discuss today is the future of money. Indeed, as central banks navigate a complex and changing landscape, we should not only aim to anticipate future trends, but also seek to shape them. In doing so, we should be particularly attentive to risks and perform a thorough analysis of their costs and benefits. ….. A central bank digital currency would allow citizens to use central bank money directly in their daily transactions. However, depending on

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I have just recently written for Moneycontrol on how European central bankers particularly French are really keen on introducing a central bank digital currency.

Christine Lagarde (who is French!), recently appointed at helm of ECB in her first hearing at the European Parliament interestingly spoke on CBDC:

The other topic you have asked me to discuss today is the future of money. Indeed, as central banks navigate a complex and changing landscape, we should not only aim to anticipate future trends, but also seek to shape them. In doing so, we should be particularly attentive to risks and perform a thorough analysis of their costs and benefits.

…..

A central bank digital currency would allow citizens to use central bank money directly in their daily transactions. However, depending on its design, a central bank digital currency could pose risks. For instance, they could alter the way in which monetary policy is conducted and transmitted to the real economy. They could also carry implications for the functioning of the global financial system and its stability. The question of central bank digital currencies and their optimal design therefore warrants further analysis.

Our ultimate goal is to foster safer, innovative and integrated payments in euro. This will in turn benefit everyone in the euro area and strengthen the euro internationally.

François Veilleroy De Galhau of Banque De France in a recent speech (4 Dec 2019), gave a more detailed speech on CBDC:

I shall turn now to a topic that is a major challenge for the future of the international monetary and financial system: the possible creation of a central bank digital currency (CBDC). The creation of a new form of currency by central banks goes beyond the challenges I have just mentioned: it is neither a precondition for nor a guarantee of more efficient payments. However, we as central banks must and want to take up this call for innovation at a time when private initiatives – especially payments between financial players – and technologies are accelerating, and public and political demand is increasing. Other countries have paved the way; it is now up to us to play our part, both ambitiously and methodically.

To this end, the Banque de France is to be reorganised. The current Direction de la surveillance des paiements et des infrastructures de marché (DSPM – Payments and Market Infrastructures Oversight Directorate) will become the Direction des infrastructures, de l’innovation et des paiements (DIIP – Infrastructure, Innovation and Payments Directorate), and its scope will be extended to cover all payment innovations, infrastructures and central bank digital currency. Additional skills will be recruited to strengthen its expertise, and, with the help of our Lab, the DIIP will work with industry innovators from the private sector: we want to start running experiments rapidly and will launch a call for projects before the end of the first quarter of 2020. We are particularly keen to take part in experiments to integrate a “wholesale” CBDC into innovative procedures for exchanging and settling tokenised financial assets. Nathalie Aufauvre, Director General of Financial Stability and Operations, will coordinate the Banque de France’s acceleration process. Our actions will naturally contribute to the work of the Eurosystem, which should make looking into the possibility of an “e-euro” one of its next focuses: Christine Lagarde referred to it on Monday in front of the European Parliament. Beyond this, we intend to take part in the work of the “innovation hub” recently created by the BIS.

On a substantive level, I would like to share with you some first thoughts – which are still open to discussion, of course – on three aspects: the objectives, externalities and possible modalities of a central bank digital currency.

1/ At this stage, I can see three different – but not mutually exclusive – objectives for digitalising central bank currency. The first relates to the desire, in countries such as Sweden where cash use is declining rapidly, to guarantee all citizens access to central bank money. A CBDC would help to preserve the trust in the financial system that stems in part from being able to exchange assets for legal tender. The second argument relates to the efficiency gains, reduced intermediation costs and resilience that would potentially result from the “tokenisation” of a central bank currency, especially in settlement and post-trade activities (which is also one of the objectives of JP Morgan’s JPM Coin project). The third and final reason – and the most important one for political authorities, including in France and Europe – is that creating a CBDC would give us a powerful lever with which to assert our sovereignty in the face of private-sector initiatives such as Libra. This is also one of the concerns highlighted by the People’s Bank of China with its Digital Currency Electronic Payment (DCEP) project.

In this context, what form should our CBDC take? Public expectations on this differ significantly from those of financial institutions. As a result, in the long term, two different uses of the CBDC could exist side by side: one for payments between financial sector players (a so-called “wholesale” currency) that uses blockchain technology and all its possibilities, notably smart contracts; and another for the general public (a so-called “retail” currency) that is simpler and better suited to retail transactions. In this respect, financial institutions are much more digitally mature than private individuals as they already access central bank currency digitally via the bank accounts they hold with the central bank. In addition, following on from the questions raised by the Governor of the Bank of England, Mark Carney, on the idea of creating an international digital currency in response to the dominance of the US dollar, I think there would be some advantage in moving rapidly to issue at least a wholesale CBDC, as we would be the first such issuer in the world and would thus reap the benefits of having a benchmark CBDC.

2/ The issuance of a CBDC can generate significant positive externalities by increasing the productivity of the financial sector and by extension the economy, and by shoring up confidence in the currency and in the financial system. But, in parallel, it is vital that we examine the potentially negative externalities that a CBDC could generate for liquidity, profitability and bank intermediation. In particular, we need to look very closely at the risks linked to large-scale and/or sudden conversions of bank deposits into central bank money.

3/ The third aspect is the modalities that could be used to circulate the CBDC, especially the “retail” version, about which we need to be particularly vigilant. I’m thinking about the issue of its legal tender status – which is not indispensable but probable; the conditions under which it can be held – in the form of accounts rather than tokens; and last, whether non-residents will have access to it, which would certainly help to raise its international status. Moreover, thanks to their proven expertise in payment instruments, know-your customer requirements and transaction monitoring, financial intermediaries will be able to play a front-line surveillance role in the distribution of the CBDC. In parallel, we will also need to launch a reflection to define the conditions under which the CBDC could circulate anonymously “from person to person”. Limits could be set for the size of anonymous transactions, such as those already applicable in France for e-money and cash payments.

Hmm..

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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