Reforming the Eurozone financial system: A system-dynamics approach

The effectiveness of the current monetary policy of the European Central Bank (ECB) in maintaining (price) stability in the eurozone is assessed using a system dynamic model. The model combines a neoclassical growth model with a stock-flow representation of the eurozone financial sector at a high level of aggregation. With endogenous money creation, the multidirectional relationship between asset prices and net income, and also the dual causality of both liquidity and investment relative to interest rates as the main features of the model, the developments of the past 50 years can be understood and extrapolated to 2050. The simulation experiments indicate that the current pro-cyclic system is inherently unstable. This instability can only be overcome by monetary policy that eases and tightens the total amount of money in the system in a countercyclical manner. An obvious way to achieve this is the introduction of 100% Central Bank Digital Currency (CBDC). This calls for the ECB's mandate to become the sole "monetary authority" that creates and controls the amount of money in the system, with the sole and unambiguous objective of price stability. Money creation to achieve price stability at a targeted level of inflation with simultaneous repayment of public debt varies between €200 billion and €500 billion per year. This money can be channelled into the real economy through the EU's governance structure and spent on tax cuts and/or direct public investments, for example in physical and social infrastructure. •The ECB is currently not up to the task of maintaining price stability within the euro area (2% inflation target).•The most obvious way to achieve price stability is to allocate money creation exclusively to the ECB (100% CBDC).•In the shorter term, price stability can be improved by non-exclusive money creation by the ECB.•CBDC-countercyclical approaches argue for an expansion of the ECB's mandate as a money creating authority.•Money created by the ECB (€200 - €500 billion) can be channeled into the real economy as tax cuts and/or direct investments.