High Road, Low Road

Among the many thorny issues that would arise if Scotland were be become an independent nation is the question of its choice of a currency. The first minister of Scotland claims that an independent Scotland would continue to use the pound. But Mark Carney, the governor of the Bank of England, has raised several caveats and stipulations—including limitations on fiscal autonomy—that would be required if a currency union were to be formed. Moreover,British elected officials have thrown cold water on the idea. And that could be a problem for an independent Scotland, as there is no obvious good alternative.

Scotland could unilaterally decide to continue using the pound, just as Panama and Ecuador use the U.S. dollar. But dependence on the United Kingdom for its money is not fully compatible with political independence. Nor is it congruent with the international status that the new country would undoubtedly seek.

How about adopting the euro? Scotland would join the current 18 members of the Eurozone, and would have to hope that it did not suffer from any Scotland-specific shocks. Optimal currency theory spells out the alternative mechanisms a country needs to address an asymmetric shock: mobile labor, flexible prices and wages, and/or a fiscal authority that can direct funds to the area facing the shock. The sight of Irish, Spanish, etc., workers leaving their respective homelands in search of work outside of Europe has hardly been reassuring to prospective members. The Baltic states have shown that prices and wages will fall in response to a policy of austerity, but the economic cost is severe. And no Scottish government would survive the harsh policy conditions attached to the financial assistance extended to Greece, Ireland and Portugal by their European partners and the IMF. Joiningthe Eurozone at this stage of its existence would not be consistent with Scottish canniness.

If Scotland can not—or will not—join an existing monetary union on terms it deems acceptable, should its create its own currency? The prospect of a Scottish currency has drawn a fair amount of comment: see, for example, here and here and here.  A study by Angus Armstrong and Monique Ebell of the National Institute of Economics and Social Research makes the point that the viability of an independent currency for the country would depend on the amount of sovereign debt the new government would have to take on after a breakup witht the United Kingdom versus its anticipated oil revenues. Standard & Poor’s issued a nuanced assessment of how it would rate Scotland’s debt that noted the country’s economic wealth, which is largely based on oil and gas. But the report also raised concerns about the viability of Scotland’s financial sector in the absence of a reputable lender of last resort.

If an independent Scotland issued its own currency, it would be joining other north European countries that either do not belong to the European Union (Iceland, Norway) or have not adopted the euro (Denmark, Sweden). These countries have certainly suffered bouts of volatility and instability (particularly Iceland), but have not fared any worse than many members of the Eurozone. Their decision not to enter the Eurozone itself is interesting and worth further analysis.

But none of them is as deeply tied to another single country as Scotland is to the United Kingdom. Disentangling those ties for the purpose of establishing national autonomy would be difficult and most likely costly. Proclaiming monetary independence, therefore, would be a policy action that makes limited sense in economic terms but carries a great deal of nationalistic baggage. And those types of ventures do not usually end well.