Central banks know deep inside that inflation is a monetary phenomenon and that is why they are hiking rates and tightening as fast as governments allow them. However, their credibility got hurt by first ignoring the inflation risk and later using the base effect and transitory excuse, only to react late and slowly. Now the Bank of Lithuania has reported the decision of the ECB Governing Council to move to the next phase of the digital euro project: the preparation phase. Trick or treat?
The ECB decision follows the completion of the investigation phase launched by the Eurosystem in October 2021 to explore possible design and distribution models for a digital euro. Based on the findings from this phase, a digital euro would be accessible to citizens and businesses through distribution by supervised intermediaries, such as banks.
The design envisages the digital euro as a digital form of cash that could be used for all digital payments throughout the euro area. It would be widely accessible, free for basic use, and available both online and offline. It would also allow users to settle payments instantly in central bank money. It could be used from person to person, at the point of sale, in e-commerce, and in government transactions.
The next phase of the digital euro project – the preparation phase – will start on 1 November 2023 and will initially last two years. It will involve finalizing the digital euro rulebook and selecting providers that could develop a digital euro platform and infrastructure. It will also include testing and experimentation to develop the requirements for both the Eurosystem and user needs, for example in terms of user experience, privacy, financial inclusion, and environmental footprint. After two years, the Governing Council will decide how to move to the next stage of preparations, to pave the way for the possible future issuance and roll-out of a digital euro.
The launch of the preparation phase is not a decision on whether to issue a digital euro. That decision will only be considered by the Governing Council once the EU legislative process has been completed. The ECB will take into account any adjustments to the design of the digital euro that may become necessary as a result of the legislative deliberations.
A central bank digital currency would be issued directly to citizens’ accounts within the central bank. As such, critics perceive it as surveillance disguised as money. Narratively, the digital euro would make data protection a priority. The Eurosystem would not be able to see users’ personal data or link payment information to individuals. The digital euro would also achieve a cash-like level of privacy for offline payments.
Users could access digital euro services via their payment service provider’s proprietary app and online interface, or via a digital euro app provided by the Eurosystem. People without access to a bank account or digital devices would also be able to pay with digital euro, for example by using a card provided by a public body such as a post office. Users would also be able to exchange digital euros for cash or vice versa at cash machines.
The Eurosystem envisions a digital euro that would be free for basic use for individuals. A compensation model between intermediaries and merchants would ensure that there are incentives for intermediaries to distribute digital euro, as is the case for other electronic payment instruments, and that there are adequate safeguards against excessive service charges for merchants.
Despite the rosy expectations, the only thing that saves citizens from much higher prices is an independent and diversified transmission mechanism of monetary policy. Moreover, central bank digital currencies appear unnecessary: the benefits of technology, digitalization, and ease of transactions are already there. And there is absolutely no need to compete with a digital yuan. China is moving closer to sound monetary policy and its central bank is purchasing more gold, not the opposite.
It looks like the only reason the Fed or the ECB wants a digital currency is that they want to retain their market share without defending the purchasing power and reserve of value status of their currency. The Fed and the ECB do not need to compete against cryptocurrencies if they show the world that they will defend the purchasing power of the US dollar and the euro.