The AAG will bring together a diverse, multi-disciplinary group of experts to encourage academic research, debate and promote discussion on a range of topics, to support the Bank and HM Treasury’s work during the design phase of a digital pound.
Alexander Edmund Voorhoeve
Professor of Philosophy
London School of Economics
Professor of Financial Economics
Andrew Theo Levin
Professor of Economics
Tenured Researcher and an Adjunct Professor in Financial Markets and Institutions
Professor of Computing
Edinburgh Napier University
Burcu Yüksel Ripley
Senior Lecturer of Law
University of Aberdeen
Danae Stanton Fraser
Professor in Human Computer interaction, CREATE Lab
University of Bath
Professor of Finance
David Robert Skeie
Professor of Finance
University of Warwick
Associate Professor in Economics
Trinity College Dublin
Professor of Macroeconomics
University of Bern & CEPR
Professor of Economics
Toulouse School of Economics
Professor and Chair of Finance
University of Edinburgh
Reader (Associate Professor) in Law and Director, Centre of Fintech
University of East London
Pro-Vice-Chancellor and Professor of Innovation & Knowledge Exchange
Katrin Assenmacher (ECB), Peter Bofinger (U of Wurzburg), Rod Garratt (UCSB, BIS), Alexandre Stervinou (Banque de France). Chair: Dirk Niepelt. One of the opening events at CEPR’s Paris Symposium 2023.
… it is critical to account for indirect in addition to direct social costs and benefits when ranking monetary architectures.
… the costs and benefits we consider point to an important role of central bank digital currency in an optimal monetary architecture unless pass-through funding is necessary to stabilise capital investment and very costly.
… the interest rate on CBDC should differ from zero and from the rate on reserves.
From the text:
Notes: The dark grey area represents the efficiency advantage of CBDC needed to make it less costly than a two-tier system with optimum reserve holdings. The light grey area displays the same object but based on actual US reserve holdings rather than model-implied optimal ones. These distributions allow for pass-through costs and tax distortions, quantified by assuming taxing households causes deadweight burdens of 25% per tax dollar. The distributions are based on two million realisations.
We analyze the role of retail central bank digital currency (CBDC) and reserves when banks exert deposit market power and liquidity transformation entails externalities. Optimal monetary architecture minimizes the social costs of liquidity provision and optimal monetary policy follows modified Friedman (1969) rules. Interest rates on reserves and CBDC should differ. Calibrations robustly suggest that CBDC provides liquidity more efficiently than deposits unless the central bank must refinance banks and this is very costly. Accordingly, the optimal share of CBDC in payments tends to exceed that of deposits.
… promoting the digital euro requires an aggressive marketing strategy because private incentives for adoption are limited. However, the pursuit of such an aggressive approach is unlikely as this runs counter to the ECB’s fourth, implicit objective of protecting banks’ existing business model.
This is problematic and could turn the project into a significant missed opportunity, for the potential social benefits of the digital euro substantially exceed its private ones.
Ein digitaler Euro könnte den Wettbewerb fördern, mehr Transparenz schaffen und das Too-big-to-fail-Problem entschärfen. Mit ihrer Minimalvariante aber priorisiert die EZB das Ziel der Bewahrung des Status quo im Bankensystem.
The ECB’s first two progress reports on the digital euro clarify the project teams’ considerations. Some motivations for a digital euro remain vague, some fundamental tradeoffs receive limited attention. Most importantly, the reports lack an analysis of why digital euro holdings as stores of value are not desirable and whether strategies to limit such holdings cause collateral damage. Against that backdrop some of the design choices backed by the Governing Council appear premature.
The two progress reports provide an insightful overview over some of the thinking underlying the digital euro project. The reports remain vague in some respects, which is not surprising given the early stage of the project and the division of tasks between the ECB and the Commission.
The first report suggests that the digital euro can help preserve public money as the anchor of the payment system, but it does not explain how the decline in cash use endangers the anchor role or how a digital euro would mitigate the associated risks. It motivates the digital euro as contributing to Europe’s strategic autonomy, but does not clarify whether the autonomy concerns national security, cheaper payment services, or monetary sovereignty, and why either of these would suggest a focus on consumers rather than business users. More generally, the report discusses few economic motives for a digital euro in depth and this raises doubts about the proper sequencing of design choices. Some arguments for privacy restrictions are not fully convincing. The most important shortcoming of the first report is the lack of analysis of why digital euro holdings as stores of value are not desirable (or why this issue is beyond discussion) and whether strategies to limit such holdings cause collateral damage.
The second report lacks a discussion of incentive compatibility of the envisioned public-private partnership model. It also lacks detail on the proposed settlement, funding and defunding models and on the incidence of the payment scheme’s costs.
The reports do not discuss implications for central bank balance sheets, interest rates, political interference, and the ECB’s mandate to introduce a digital euro.
My colleague Cyril Monnet also wrote a report (PDF). His executive summary:
Since Facebook’s announcement of Libra in July 2019, central banks, including the European Central Bank (ECB), have accelerated investigations on the introduction of their own retail digital currency.
This study analyses the two reports published by the ECB regarding its investigation for the introduction of a digital euro.
The digital euro can offer many advantages over existing means of payment. However, most of these benefits, as outlined in the two reports, are of a systemic and social nature, rather than being benefits for users.
A broad acceptance and usage of the digital euro requires that it brings benefits not only to consumers but also to merchants. The digital euro needs a platform business model that brings consumers but also incentivises merchants to adopt it.
In addition, considering the social benefits it brings, the ECB should design the digital euro to promote its appeal. The ECB should consider eliminating holding limits and discontinuing penalising remuneration schemes as soon as possible after its introduction. Also, the ECB should consider adding some programmability features to the digital euro.
There are also some challenges ahead.
The deployment of the digital euro by regulated intermediaries results in a conflict of interest, as the digital euro competes with a significant source of their revenue, i.e. payments. To restrict the fees charged to users of the digital euro by intermediaries, the ECB should consider implementing a transparent fee structure that may incorporate subsidies.
Also, while consumers use cash to preserve their anonymity, the digital euro will always leave a data trail. It is therefore key that the future design of the digital euro preserves at least the privacy of its users, which may require the central bank to make compromises with some other objectives.
It is not clear that distributed ledger technology (DLT) is the best way to deploy the digital euro but making it DLT compatible and programmable can foster innovations in decentralised finance.
Update, late May 2023: Christian Hofmann also wrote a report (PDF). His executive summary:
… This paper argues that the paramount reason for introducing a digital euro should lie in the imperfections of the existing money landscape that offers the public suboptimal choices for store of value and payment transactions. In that respect, the introduction of a digital euro holds great promise for the public, and this paper focuses on one of the most essential design features of a digital euro. The European Central Bank (ECB) plans to introduce a limited version of a digital euro that would cap the maximum amounts of digital euros that individuals can hold, but this paper challenges the ECB’s assumption that such caps are needed in the interest of financial stability. The concerns voiced by the ECB and other central banks about the risks from sudden outflows of liquidity from bank deposits to CBDC are realistic, but this paper argues that these risks are manageable and that a digital euro might even support financial stability in a banking crisis. Properly implemented, an unlimited digital euro would allow central banks and other authorities to wield control more effectively during bank run scenarios and improve their overall ability to manage crises situations.
But some argue banks would work fine if the public switched their deposits for central-bank digital currencies, so long as the central bank stepped in to replace the lost funding. “The issuance of [such currencies] would simply render the central bank’s implicit lender-of-last-resort guarantee explicit,” wrote Markus Brunnermeier and Dirk Niepelt in 2019. This scenario seems to have partly materialised since the failure of svb, as deposits have fled small banks for money-market funds which can park cash at the Fed, while the Fed makes loans to banks.
Three BIS innovation hubs plan to test DeFi inspired liquidity pools to exchange wCBDCs. BIS press release:
Project Mariana will use DeFi protocols to automate foreign exchange markets and settlement.
Automated market makers can become the basis for new generation of financial infrastructure.
Exploration on cross-border exchange of wholesale CBDCs is the first to involve three Hub centres.
The BIS Innovation Hub is launching a new project around central bank digital currencies (CBDCs) and Decentralised Finance (DeFi) protocols as part of its 2022 work programme.
Project Mariana explores automated market makers (AMM) for the cross-border exchange of hypothetical Swiss franc, euro and Singapore dollar wholesale CBDCs. It will seek to examine the potential between financial institutions to settle foreign exchange trades in financial markets.
The project involves the Eurosystem, Singapore and Switzerland BIS Innovation Hub Centres together with the Bank of France, Monetary Authority of Singapore and Swiss National Bank. The aim is to deliver a proof of concept by mid-2023.
Project Mariana uses DeFi protocols to automate foreign exchange markets and settlement, potentially improving cross-border payments (and supporting a priority of the Group of 20). Today, DeFi built on public blockchains uses smart contract protocols to automate markets for crypto and digital assets. AMM protocols combine pooled liquidity with innovative algorithms to determine the prices between two or more tokenised assets. In the future, similar AMM protocols could form the basis for a new generation of financial infrastructures facilitating the cross-border exchange of CBDCs.
We analyze retail central bank digital currency (CBDC) in a two-tier monetary system with bank deposit market power and externalities from liquidity transformation. Resource costs of liquidity provision determine the optimal monetary architecture and modified Friedman (1969) rules the optimal monetary policy. Optimal interest rates on reserves and CBDC differ. A calibration for the U.S. suggests a weak case for CBDC in the baseline but a much clearer case when too-big-to-fail banks, tax distortions or instrument restrictions are present. Depending on central bank choices CBDC raises U.S. bank funding costs by up to 1.5 percent of GDP.
Digitisation rapidly changes money, banking and finance. Are these changes fundamental and radical—or part of a continuous process of technological progress and efficiency improvement? Do academics have to re-think money, banking and finance—or do conventional theories apply? And do finance professionals and regulators need to re-assess their frameworks and tools to keep up with the transformation?
Darrell Duffie (Stanford University and Fintech & Digital Currencies RPN Member), Todd Keister (Rutgers University and Fintech & Digital Currencies RPN Member) and Harald Uhlig (University of Chicago, CEPR and Fintech & Digital Currencies RPN Member), three experts on macro economics, monetary economics and finance, shared their views on these and related questions. The webinar, which has been moderated by Dirk Niepelt (University of Bern, SUERF, CEPR and Fintech & Digital Currencies RPN Leader), started with brief opening remarks by each of the experts, followed by a discussion and a Q&A session.
Mr. Lee (for himself and Mr. Braun) introduced the following bill; which was read twice and referred to the Committee on Banking, Housing, and Urban Affairs
To amend the Federal Reserve Act to limit the ability of Federal Reserve banks to issue central bank digital currency.
Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,
SECTION 1.SHORT TITLE.
This Act may be cited as the “No Central Bank Digital Currency Act” or the “No CBDC Act”.
SEC. 2. CENTRAL BANK DIGITAL CURRENCY.
Section 13 of the Federal Reserve Act is amended by adding after the 14th undesignated paragraph (12 U.S.C. 347d) the following:
“ No Federal reserve bank, the Board, the Secretary of the Treasury, any other agency, or any entity directed to act on behalf of the Federal reserve bank, the Board, the Secretary, or other agency, may mint or issue a central bank digital currency directly to an individual (including central bank digital currency issued to an individual through a custodial intermediary) or a digital currency intermediary, offer related products or services directly to an individual, or maintain an account on behalf of an individual (including an account in a specially designated account at a digital currency intermediary or supervised commercial bank). No Federal reserve bank may hold digital currencies minted or issued by the United States Government as assets or liabilities on their balance sheets or use such digital currencies as part of fulfilling the requirements under section 2A.”.
Orell Füssli Ltd. Security Printing and AUGENTIC GmbH announced their partnership on a “Smart Banknote CBDC” solution including trustwise.io’s Distributed Ledger Technology (DLT) a week ago. A smart banknote is a physical banknote that interacts with a CBDC solution and acts as a transitional device between traditional and CBDC based payment systems. A smart banknote can be used like a classic banknote; however, the owner can redeem his cold wallet (physical banknote) and transfer the note’s value to a digital wallet by scanning the QR code with the private key. Our smart banknote includes a public and a private key represented by QR codes of which the private one is sealed. When the cover of the private key is removed, the QR code scanned, the value of the banknote can be transferred to a digital wallet. Conceptually after this procedure, the smart banknote cannot be transferred anymore.
An executive order dated March 9, 2022 outlines what is on the White House’s mind:
The United States has an interest in responsible financial innovation, expanding access to safe and affordable financial services, and reducing the cost of domestic and cross-border funds transfers and payments, including through the continued modernization of public payment systems. We must take strong steps to reduce the risks that digital assets could pose to consumers, investors, and business protections; financial stability and financial system integrity; combating and preventing crime and illicit finance; national security; the ability to exercise human rights; financial inclusion and equity; and climate change and pollution. …
(d) We must reinforce United States leadership in the global financial system and in technological and economic competitiveness, including through the responsible development of payment innovations and digital assets. The United States has an interest in ensuring that it remains at the forefront of responsible development and design of digital assets and the technology that underpins new forms of payments and capital flows in the international financial system, particularly in setting standards that promote: democratic values; the rule of law; privacy; the protection of consumers, investors, and businesses; and interoperability with digital platforms, legacy architecture, and international payment systems. The United States derives significant economic and national security benefits from the central role that the United States dollar and United States financial institutions and markets play in the global financial system. Continued United States leadership in the global financial system will sustain United States financial power and promote United States economic interests.
In a speech, the ECB’s Fabio Panetta argues that a digital Euro is necessary because
[i]n the digital age … banknotes could lose their role as a reference value in payments, undermining the integrity of the monetary system. Central banks must therefore consider how to ensure that their money can remain a payments anchor in a digital world.
He argues that
outsourcing the provision of central bank money [to stable coin providers] … would endanger monetary sovereignty [as would the absence of a national digital currency].
Panetta also argues that a digital Euro could
improve the confidentiality of digital payments and
increase choice and reduce costs
avoid interfering with the functioning of the financial system and