The next generation of digital currencies: in search of stability. Bruegel Policy Contribution Issue #15 December 2019

Four major developments have challenged the status quo and reopened the debate on the forms that money will take in the future: 1) use of cash as a medium of exchange has declined; 2) distributed ledger technology (DLT) has led to the emergence of thousands of digital cryptocurrencies; 3) some global tech giants are planning to provide private digital currencies to their billions of users in the form of stablecoins; and 4) in turn, public authorities are thinking about providing their own digital currencies to the general public. • These developments raise questions about the implications for financial stability, the transmission of monetary policy and financial intermediation. This Policy Contribution focuses on the consequences stablecoins and central bank digital currencies could have. • Stablecoins, such as Facebook’s Libra, differ from earlier generations of cryptocurrencies in three fundamental ways. First, they would start with large networks of users and global accessibility, two pivotal features for the critical uptake of a new currency. Second, given the current limitations of DLT, including in terms of energy efficiency, new stablecoins would rely on (more) centralised systems to validate transactions. Third, stablecoins would focus particularly on reducing the volatility in the value of the new currency. • These new features of stablecoins attempt to correct some of the critical deficiencies identified in first-generation cryptocurrencies, which meant they did not acquire the main functions of money. However, new stablecoins raise other questions and potentially create new problems. One issue could arise from the more centralised (permissioned) validation system, which could lead to collusion problems. Another issue could arise from the reserve system that is supposed to ensure the stability of stablecoins, such as Libra, which could be incompatible with the profit maximisation behaviour of a private issuer. • Facebook’s Libra plan has been a wake-up call to central banks and governments which, afraid of losing their monetary sovereignty, have renewed their interest in central bank digital currencies (CBDCs) as a potential solution. CBDCs could make private digital currencies less attractive and slow down their adoption. • But there are other reasons to give the general public access to central bank liabilities. One important reason to provide CBDCs to citizens is that if cash disappears, citizens will lose direct access to sovereign money. Another benefit of the introduction of CBDCs is that monetary policy could be strengthened by transmitting it directly to the general public. • However, the introduction of CBDCs could also be disruptive and create risks. In particular, CBDCs could have major consequences for financial intermediation. These risks would have to be evaluated by policymakers before any decisions are taken. • If CBDCs are introduced, central banks would have to carefully calibrate their properties to minimise these risks. But, eventually, if these risks – and in particular the risk of structural financial disintermediation – do materialise, central banks would have various instruments to counter the

The missing pieces of the euro architecture. Bruegel Policy Contribution Issue n˚28 | October 2017

What are the remaining fragilities of the Euro architecture? This policy contribution assesses the institutional reforms put in place during and after the crisis and make some proposals for a coherent economic governance framework to make Europe’s monetary union more resilient

Low long-term rates: bond bubble or symptom of secular stagnation? Bruegel Policy Contribution Issue n˚15 | 2016

Yields on European sovereign bonds have reached historically low levels in 2016. This secular decline in long-term sovereign yields is not limited to the euro area. Why are interest rates currently so low? Are low long-term rates justified by fundamental factors or is it an artificial phenomenon

The European Central Bank in the COVID-19 crisis: whatever it takes, within its mandate. Bruegel Policy Contribution Issue n˚9 | May 2020.

Central banks have taken drastic steps to keep their economies afloat during the COVID-19 lockdowns. In the euro-area, the European Central Bank (ECB) has eased significantly the conditions of its refinancing operations and has announced a new asset purchase programme. This response has triggered fears of a significant increase in inflation, and concerns about whether the ECB measures are compatible with its pricestability mandate and with the limits set by the EU Treaties. Accelerating inflation is not an immediate threat, as the euro area will experience in 2020 its deepest recession ever recorded. Initially, the pandemic took the form of a supply shock, but second-round effects have now generated a massive aggregate demand shock. The overall impact on prices will depend on which of these two shocks dominates, but at this stage, it seems that deflationary forces are likely to dominate and bring headline inflation into negative territory in the near future. An expansionary monetary policy is thus clearly warranted for the ECB to fulfil its price-stability mandate. Moreover, given the severity of the shock, there is currently no trade-off between the ECB’s primary mandate and its secondary macroeconomic objectives, which all point in the same direction. New measures implemented by the ECB also seem to respect the legal boundaries set by the EU Treaties and the criteria set by the EU Court of Justice in its rulings on previous ECB asset purchase programmes. However, the legal situation has been complicated by the 5 May 2020 ruling of the German Constitutional Court (GCC) on the ECB’s 2015 Public Sector Purchase Programme. The ECB is not under the GCC’s jurisdiction and it is difficult to predict how the legal situation will evolve, but from an economic perspective, if the ECB were to abide by the more stringent rules dictated by the GCC, it would make it harder for the ECB to fulfil its primary mandate and secondary objectives. The ECB’s current actions and the increase in the size of its balance sheet, even if it were to prove permanent, should not restrict significantly its ability to increase rates to fulfil its price-stability mandate. The ECB would have enough tools at its disposal to counter a surge in inflation if it were to happen. While the ordering is clear between the ECB’s primary price-stability mandate and its secondary objectives, the secondary goals are not ranked by priority, possibly creating difficult trade-offs. Dealing with these is a political task and the ECB should welcome some clear guidance from the European Parliament and EU Council on which secondary objectives are the most relevant for the EU in a particular situation

5. FACING THE LOWER BOUND: WHAT WILL THE ECB DO IN THE NEXT RECESSION? Bruegel Study 2020

In responding to the global financial crisis and its aftermath, the ECB has pushed its monetary policy into unchartered territories over the past decade. Today, it appears increasingly constrained by persistently low interest rates and the uncertainty of the environment it operates in. This paper seeks to understand these new challenges and assess whether its current toolkit will allow the ECB to weather the next European recession. We make five key recommendations: first, the ECB must find a way to mitigate the potentially negative effects of its negative interest rate policy; second, it must rethink the issuer limit on its asset purchase program; third, a review of its monetary policy framework is in order; fourth, it must be fully prepared to use its outright monetary transactions (OMT) program; and finally, more innovative unconventional policies might be necessary

How good is the European Commission’s Just Transition Fund proposal? Bruegel Policy Contribution Issue n˚4 | February 2020

On 14 January 2020, the European Commission published its proposal for a Just Transition Mechanism, intended to provide support to territories facing serious socioeconomic challenges related to the transition towards climate neutrality. This brief provides an overview and a critical assessment of the first pillar of this Mechanism, the Just Transition Fund (JTF)

How should the European Central Bank ‘normalise’ its monetary policy? Bruegel Policy Contribution Issue n˚31 | November 2017

During the crisis, the ECB resorted to a number of unconventional monetary tools. This paper discusses how to phase out these policies and what the ‘new normal’ in monetary policy should look like

The European Globalisation Adjustment Fund: Easing the pain from trade? Bruegel Policy Contribution Issue n˚05 | March 2018

With the European Globalisation Adjustment Fund (EGF), the EU now has an instrument to help workers negatively affected by trade find new jobs. However, only a small proportion of EU workers affected by globalisation receive EGF financing. How to improve the EGF? Revising the eligibility criteria to qualify for EGF assistance, enlarging the scope of the programme beyond globalisation and collecting more and better data to enable a proper evaluation of the programme

The European Central Bank’s quantitative easing programme: limits and risks. Bruegel Policy Contribution Issue 2016/04, February 2016

The European Central Bank (ECB) has made a number of significant changes to the original guidelines of its quantitative easing (QE) programme since the programme started in January 2015. These changes are welcome because the original guidelines would have rapidly constrained the programme’s implementation. The changes announced expand the universe of purchasable assets and give some flexibility to the ECB in the execution of its programme. However, this might not be enough to sustain QE throughout 2017, or if the ECB wishes to increase the monthly amount of purchases in order to provide the necessary monetary stimulus to the euro area to bring inflation back to 2 percent. To increase the programme’s flexibility, the ECB could further alter the composition of its purchases. The extension of the QE programme also raises some legitimate questions about its potential adverse consequences. However, the benefits of this policy still outweigh its possible negative implications for financial stability or for inequality. The fear that the ECB’s credibility will be undermined because of its QE programme also seems to be largely unfounded. On the contrary, the primary risk to the ECB’s credibility is the risk of not reaching its 2 percent inflation target, which could lead to expectations becoming disanchored

The financial stability risks of ultra-loose monetary policy. Bruegel Policy Contribution Issue 2015/03

Ultra-loose monetary policies, such as very low or even negative interest rates, large-scale asset purchases, long-maturity lending to banks and forward guidance in central bank communication, aim to increase inflation and output, to the benefit of financial stability. But at the same time, these measures pose various risks and might create challenges for financial institutions. • By assessing the theoretical literature and developments in the United States, United Kingdom and Japan, where very expansionary monetary policies were adopted during the past six years, and by examining the euro-area situation, we conclude that the risks to financial stability of ultra-loose monetary policy in the euro area could be low. However, vigilance is needed. • While monetary policy should focus on its primary mandate of area-wide price stability, other policies should be deployed whenever the financial cycle deviates from the economic cycle or when heterogeneous financial developments in the euro area require financial tightening in some but not all countries. These policies include micro-prudential supervision, macro-prudential oversight, fiscal policy and regulation of sectors that pose risks to financial stability, such as construction