The Referendum on Separation for Scotland: no doubt-no currency union - Scottish Affairs Committee Contents

2  Currency options

Why does the choice of currency matter?

10.  No decision matters more for a country's economy than what currency it uses. It has far reaching economic implications, determining the terms of trade with other countries, and the interest rates paid on borrowing and lending, including, for example, mortgages for homebuyers and loans to businesses seeking to invest. A trusted, stable, currency is one of the greatest assets at country can have.

11.  Today, within the United Kingdom, Scotland uses the pound sterling as its currency, in a full economic union with other nations of the UK. In the event of a 'yes' vote on 18 September, a new Scottish State would have to make a choice about what currency to use, as that is a central economic power which would arise from separate statehood.

12.  There are four main options in relation to its choice of currency, which would form the basis for the Scottish Government's negotiations with the UK Government:

  • using the pound as part of a currency union with the continuing UK;
  • using the pound unilaterally ("sterlingisation");
  • adopting the Euro; or,
  • creating a separate Scottish currency.

13.  Each option comes with potential risks and pitfalls, as well as advantages. As Professor John Kay, visiting Professor of Economics, London School of Economics explained, there are three basic choices: currency union with the Euro; currency union with the UK; and an independent Scottish currency.[7] He has subsequently suggested that "sterlingisation", or an 'informal currency union' is also an option.[8]

14.  A currency union between countries eliminates transaction costs which arise from having to change currency and removes the risks to trade arising from exchange rate fluctuations. This reduces the costs of trade between countries sharing the same currency.[9] However, membership of a currency union means monetary policy is set for the currency area as a whole and may be less appropriate for an individual part or member of that area. Membership of a currency union would mean accepting constraints on some economic policies in order to maintain the stability of the financial system,[10] and involves accepting constraints on the level of government debt and borrowing.[11] It also requires the agreement of the other country or countries involved. These issues are evident in the Eurozone.

15.  A separate currency gives a country an extra policy lever through its ability, at least in theory, to run an independent exchange rate and monetary policy. This can give greater flexibility in adapting to economic shocks. It also allows a country to set interest rates in response to its own economic circumstances.[12] Creating a new currency is, however, a major undertaking. It would involve transitional costs, such as the costs of introducing new notes and coins, changing prices and contracts to reflect the new currency, and the costs as businesses and households adapt to the new currency.[13] No estimate of the size of these transitional costs for the establishment of a separate Scottish currency has yet been identified. However, there is the great advantage that a decision to establish a new Scottish currency could be made unilaterally by a separate Scotland.

Currency union

16.  The Scottish Government's current stated preferred option is for a formal currency union with the continuing UK, which would mean that, in the event of separation, Scotland would continue to use the pound and the Bank of England would continue to undertake the functions of the central bank of Scotland.[14] A formal currency union could not be decided unilaterally by a separate Scotland but would require the agreement of the UK Government. It would also, assuming Scotland eventually became a Member State of the EU, require the negotiation of special provision in the EU treaties, which state that each Member State must have its own central bank and financial services regulator.[15]


17.  In terms of monetary policy, the Scottish Government's Fiscal Commission Working Group has argued that economic conditions are similar in both Scotland and the rest of the UK, and that both economies are highly integrated through both trade and migration[16], so a single interest rate and monetary policy would be suitable. The Scottish Government states that, in the event of separation, a formal currency union would be in the best interests of both Scotland and the continuing UK.[17]

18.  On 29 January 2014, Mark Carney, Governor of the Bank of England, delivered a lecture in Edinburgh, in which he set out the conditions that are necessary for a successful and stable currency union.[18] He outlined the well-established requirements of an optimal currency area: integrated economies, the free flow of capital and labour and a similar response to external shocks. However, he added that successful currency unions also require both banking and fiscal unions. Banking union is necessary so that problems in the financial system can be resolved quickly and authoritatively, in order to preserve financial stability. Fiscal union is necessary so that taxpayer resources could, where required, support the economies of different parts of the currency union. Drawing on international experience, Mr Carney suggested that stable and successful currency unions require a national authority, operating across the whole union, which has control over funds amounting to around 25% of GDP, comparable in UK terms to about one half of public spending.[19] That last condition would not be met should Scotland become a separate State.

19.  The UK Government's analysis[20] points out that as a result of 'border effects', it could be expected that the Scottish and UK economies would gradually diverge post separation, so that the same exchange rate and interest rate policies would not be suitable for either State in the long term. Given the size of the rest of the UK's economy in comparison to Scotland's, monetary policy within a currency union would be more likely to reflect economic conditions in the rest of the UK, rather than conditions in Scotland. In the event of a currency union, post separation, the Scottish Government would, in effect, be handing over control of its monetary policy and hence much of its economic policy, to what would have become another country, in which it had no representation and over whose decisions it would have no say.

20.  Sir Nicholas MacPherson, the Permanent Secretary to the UK Treasury, took the unusual step of publishing his advice to Ministers on this issue. He advised against a currency union, and drew particular attention to the problem that it would only be seen to be stable for so long as it was seen to be permanent. Given that the position of the Scottish Government is that currency union was something which could be opted out of at a later date, Sir Nicholas concluded that a currency union between Scotland and the UK would not be in the interests of the continuing UK.[21]


21.  The requirement of fiscal union to underpin a currency union is crucial. The Governor of the Bank of England emphasised that currency union without fiscal union was likely to leave parts of the currency union subject to great pressure if the common exchange rate was unsuitable for both economies.[22] This was reinforced in evidence to us by Dr Angus Armstrong, Director of Macroeconomics, National Institute for Social and Economic Research. He explained:

    You need to have some fiscal arrangements so that if there is another financial crisis-let's hope there is not another financial crisis one day but they do tend to reoccur-there is a mechanism by which one state could have a claim on the other state […] If you want to have the currency union that is pointed out in the White Paper, it implies that you need to have some sort of banking union, which implies that you need to have some sort of fiscal arrangement between the two sovereign states.[23]

22.  The Scottish Government has said voting yes in the referendum would mean that: "the most important decisions about our economy and society will be taken by the people who care most about Scotland, that is by the people of Scotland".[24] Nonetheless, it accepts that a currency union would mean that there would be substantive control over levels of government borrowing and debt, in what it describes as a 'fiscal pact'. The Scottish Government says that although Scotland would not have control over monetary policy, policy levers such as taxation, spending and competition policy would still be available to varying degrees.[25]

23.  We cannot envisage a situation in which such economic constraints would be acceptable to a Scotland that had decided to become a separate state; indeed, such constraints could very well be contrary to an independent Scotland's interests. The UK Government has stated:

    A formal currency union between the continuing UK and an independent Scottish state could place a number of demands on fiscal arrangements. It would require a more active fiscal policy to stabilise the economy in response to shocks, in a context where market discipline would reduce the scope for fiscal stabilisation. In addition, it would create important fiscal risks for the continuing UK that it would seek to minimise in any negotiation to form a sterling currency union with an independent Scotland. These conditions would be likely to reduce the sovereignty of the new independent Scottish state over its fiscal choices.[26]

In such a situation, a separate Scotland's interest rates and key aspects of its public finances, tax and spending choices would be decided by a Government and in a Parliament where Scotland was no longer represented.


24.  Events of recent years have shown the necessity of stable monetary and financial systems. The Governor of the Bank of England pointed out that there must be well established arrangements for a banking union within any currency union, so that institutions which get into trouble can, if need be, be rescued and stabilised.[27] The mechanisms for how this process is currently managed in the UK are set out in the UK Government's Scotland Analysis Paper on banking and financial services.[28] These arrangements include a central bank which can provide liquidity to any institution which needs it provided that it is in a position of underlying solvency, a deposit compensation scheme to deal with the possibility that banks may be unable to meet their obligations to customers, and a prudential and customer regulatory framework which is intended to minimise the risks of instability and misconduct.[29] All of these schemes depend ultimately on the resources of government. The Bank of England is backed up by the resources of the UK taxpayer.

25.  The House of Lords Economic Affairs Committee has cast doubt on whether the Bank of England would be willing to provide central bank services to financial institutions operating in a separate Scotland.[30] The then Secretary of State for Scotland, Rt Hon Michael Moore MP, told the House of Lords Committee that the Government "would have serious doubts over wanting to provide the lender of last resort facility".[31]

26.  Despite this, the Scottish Government maintains that: "it is clearly in the interests of Scotland, and the rest of the UK, for an independent Scotland to share the pound within a monetary union after independence".[32] The UK Government disagrees, noting:

    [...] [T]he economic rationale for the UK to agree to enter a formal sterling union with another state is not clear. The recent experience of the Euro area has shown that it is extremely challenging to sustain a successful formal currency union without close fiscal integration and common arrangements for the resolution of banking sector difficulties. For independent countries to design and agree on such a complex and untested institutional framework would be very challenging.[33]

27.  In evidence to us, Dr Angus Armstrong said there are "two fundamental problems" with negotiating a currency union. First, he noted:

    One country is 10 times the size of the other. You can't really get round this thing; it is just a fact. It is conceivable-let's hope it never has to happen-that Scotland could need some support from the rest of the UK one day, but it is pretty inconceivable that Scotland could give support for the rest of the UK. It is just too small.[34]

Second, he identified that:

    after a yes vote, there would be two independent sovereign states, it means you can pull out at any time. Forming international agreements for countries that can always have a vote and decide the will of the people becomes very difficult. That is why in international law it is so hard to make binding agreements.[35]

28.  Furthermore, Ronald MacDonald, Professor of Economics, Glasgow University, argued that a currency union between Scotland and the continuing UK was not the most appropriate regime for an independent country.[36] He explained one of the key reasons for this was that, post separation, Scotland would be allocated a share of the UK's oil. He said: "as soon as you do that, you open the country to what we call "asymmetric shocks," because the rest of the UK is not going to be an oil producer".[37] Any sovereign State requires some way of adjusting to these shocks. Professor MacDonald explained one way is through a transfer mechanism, "which works very well at the moment in the UK because the shocks are internalised within the whole country".[38] However, a separate Scotland would need some mechanism to adjust that. One of the key measures is that the nominal exchange rate would adjust. He said: "If you had a separate currency, your exchange rate would take up the adjustment, but, of course, if you are part of a monetary union, you won't have that".[39]

29.  The risks identified are not just potential risks for Scotland, but to the rest of the UK. Professor MacDonald said because Scotland is a relatively small portion of the UK:

    if they were to get the currency arrangements wrong, it could have very significant effects for the rest of the UK. It could lead to a currency crisis. If there was great international unease about the currency arrangements within the UK, speculators and international investors would be inclined to move assets out of sterling, out of the UK basically, which could lead to a very precipitous fall in sterling, with all the consequences that could have for the rest of the economy.[40]


30.  A formal currency union works well for Scotland in the United Kingdom today because of the integrated nature of our economy and, most importantly, because the nations of the UK share a fiscal and political union. Our witnesses made clear that these conditions were necessary for a currency union to be stable in the long run. A separate Scotland's economy would be likely to diverge from that of the United Kingdom, and in the absence of a fiscal union, that could mean that the exchange rate for sterling would no longer be appropriate for Scotland's economy.[41] Furthermore, Scotland would have no direct influence over the monetary institutions of the rest of the UK, and would tie itself to economic decisions over which it had no influence, so Scotland would have less control over its economic destiny than it has today. For similar reasons, we heard that currency union after separation would not be in the interests of the continuing UK either, as the rest of United Kingdom would be taking on risks from the Scottish economy over which it had no control.[42]

31.  The Scottish Government frequently asserts that because Scotland shares a currency within the UK today, sterling is one of the assets of the United Kingdom which must be shared, or shared out, after separation.[43] This argument is, at best, based on a misunderstanding of the nature of our currency and the currency union. The UK's assets and liabilities would have to be shared on a fair and equitable basis in the event of separation, but as Adam Tomkins clearly explained:

    The currency is not an asset; the currency is a means of exchange. The currency does not belong to England any more than it belongs to Scotland. It is not an asset to be apportioned. Individual pound coins or bars of gold, if there are any left in the Bank of England's reserves, are assets that would fall to be apportioned equitably, presumably on a per share of population or something like that, between the two states in the event of independence. […] there is an awful lot of misunderstanding in Scotland around what would happen in the event of a yes vote. There is that misunderstanding in Scotland because Scottish Government Ministers and their supporters routinely confuse the legal position with regard to assets and liabilities with the legal position with regard to institutions.[44]

32.  As the Chancellor of the Exchequer also explained: "a currency is much more than the pieces of paper that bank notes are printed on or the metal that is stamped to create a coin. What stands behind it is not a building, like the Bank of England; it is an arrangement. It is 30 million UK taxpayers; it is the monetary framework of the UK. That is what makes for a currency."[45]

33.  The First Minister has consistently repeated, however, that "if there is no legal basis for Scotland having a share of the public asset of the Bank of England then there is equally no legal basis for Scotland accepting a share of the public liability of the national debt".[46] Professor Tomkins told us this assertion is based on the Scottish Government's refusal to accept the key distinction between assets and liabilities. He stated that, legally, this was an "entirely incoherent position" for the Scottish Government to have adopted. He explained, as noted above, "the pound itself, is not an asset to be apportioned, and yet it is frequently, in the Scottish Government's rhetoric, equated with the national debt.[47]


34.  In the light of these clear disadvantages of a currency union for both Scotland and the UK, the three largest UK political parties have ruled out the possibility of a currency union or an agreement to share sterling with a Scotland in the event of separation. Giving a speech in February 2014, Rt Hon George Osborne MP, Chancellor of the Exchequer said:

    If Scotland walks away from the UK, it walks away from the UK pound. […] We have seen how it would be impossible to construct an acceptable banking union, or fiscal union… On this basis, the official advice I have received from civil servants in the Treasury is that they would not recommend a currency union to the Government of the continuing UK. I could not as Chancellor recommend that we could share the pound with an independent Scotland. The evidence shows it wouldn't work. It would cost jobs and cost money. It wouldn't provide economic security for Scotland or for the rest of the UK. The Scottish Government says that if Scotland becomes independent there will be a currency union and Scotland will share the pound. People need to know-that is not going to happen.[48]

35.  On the same day, in an article in The Scotsman, Rt Hon Ed Balls MP, Shadow Chancellor of the Exchequer, also ruled out the possibility of a currency union:

    I am clear that the next Labour Government cannot enter into a new sterling monetary union to share the pound with an independent Scotland.[…] I want Scotland to stay in the UK. But if Scotland were to vote to break away, then I do not believe a currency union would be in the interests of either an independent Scotland or the rest of the UK.[49]

As part of this co-ordinated response, Rt Hon Danny Alexander MP, Chief Secretary to the Treasury, agreed. He said:

    As a Scot and as Liberal Democrat Chief Secretary to the UK Treasury, on the basis of this analysis, I couldn't recommend a currency union to the people of Scotland and my party couldn't agree to such a proposition for the rest of the UK.

    The SNP continue to pretend that an independent Scotland could continue to share the pound. It couldn't, without agreement. […] It simply isn't going to happen. The SNP now need to work out what their alternative currency proposal is and set it out openly.[50]

36.  However, within weeks of these statements, it was reported in The Guardian that a "Government minister at [the] heart of [the] pro-union campaign" said "of course there would be a currency union"[51]. The unnamed minister also reportedly said "you simply cannot imagine Westminster abandoning the people of Scotland. Saying no to a currency union is obviously a vital part of the no campaign. But everything would change in the negotiations if there were a yes vote".[52] While the UK Government was quick to deny these claims, the unknown Minister's comments appeared to echo the earlier comments of the First Minister, who reported that Sir Mervyn King, now, Lord King of Lothbury, then Governor of the Bank of England, had told him privately that "your problem is what they (the Treasury) say now, and what they say the day after a Yes vote in the referendum are two entirely different things".[53]

37.  Speculation has continued about whether the continuing UK would agree to enter a currency union with a separate Scotland. The Scottish Government asserts that it would be in the interests of the continuing UK to be in a currency union with Scotland, as Scotland is a major trading partner and the exchange rate costs and risk would be damaging for business. In response, the Chancellor of the Exchequer has pointed out that the UK has more trade with the Eurozone than with Scotland, and therefore, on the basis of that argument, Scotland should surely adopt the Euro.[54]. As Professor Ronald McDonald explains, the risks from a collapsing currency union dwarf any gains from reduced transaction costs:

    The certain collapse of such a union would be hugely costly for a Scottish Government and the rest of the UK and create huge uncertainty for all parties involved. The kind of sums that are currently being mentioned as the transactions costs of not re-forming a monetary union with rUK would be small beer indeed compared to the massive costs of the inevitable collapse of the monetary union.[55]

In evidence to us since then, the Chancellor of the Exchequer, Shadow Chancellor of the Exchequer and Chief Secretary to the Treasury categorically and unequivocally ruled out, in very clear and definitive terms, the idea that the continuing UK would enter into a currency union with a separate Scotland.

38.  All three senior politicians made this firm commitment to a Parliamentary Committee; that they would not lead the continuing UK into a currency union with Scotland, in any circumstances. Despite being given several opportunities to add caveats or conditions to this commitment, all three remained firm that there would be no currency union-thus ruling out any possibility of a currency union being negotiated with a UK Government, whatever its political complexion may be after the 2015 General Election. The Chancellor of the Exchequer stated clearly "the fact is—no ifs, no buts—that Scotland will not be able to share the pound if it votes to become independent".[56] The Chief Secretary to the Treasury stated categorically that a currency union was "off the table"[57], and the Shadow Chancellor of the Exchequer stated that, in the event that he became Chancellor, "It would not happen, it should not happen, and it will not happen if there is a Labour Government".[58] He continued:

    our position is unequivocal: it would not be in the interests of the rest of the UK or Scotland to attempt to negotiate a currency union. It can't be negotiated. It would be flawed, risky and unstable, and I wouldn't embark upon it. No ifs, no buts.[59]

39.  The Chancellor of the Exchequer re-emphasised the rationale for this position:

    I have an obligation to put the facts in front of the people of Scotland as they make this decision, and the fact is—no ifs, no buts—that Scotland will not be able to share the pound if it votes to become independent. It is therefore incumbent on those who want Scotland to become independent and who want to take this great economic risk to spell out what their plan is. I have heard no plan.[60]

40.  The Chancellor of the Exchequer told us:

    So why is it not in the interests of the rest of the United Kingdom? Because ultimately you would be asking UK taxpayers to provide a safety net to a separate country, which, by the way, has a very large banking system and a much smaller economy. It would be like sharing the bank account and credit card after a divorce.

    I do not think that it would be in the interests of the people of Scotland either, because they would be tying themselves to the economic decisions of another country; the interest rate decisions of a Bank of England that they were not involved with anymore; and the tax and spend decisions of this Parliament, where there would not be Scottish Members of Parliament representing their interests. So I do not think that it is in either the UK's or Scotland's interests.[61]

41.  The Chief Secretary to the Treasury told us:

    The best thing for Scotland is to stay part of the United Kingdom. The best way to keep the pound—in fact the only way to keep the pound—and keep all the benefits of a common currency and all those things is to stay part of the United Kingdom.[62]

42.  The Shadow Chancellor of the Exchequer said:

    If Scotland leaves the rest of the UK, Scotland will have fewer jobs, higher interest rates, less investment and less money for public services, and the rest of the UK will lose in terms of jobs and investment too. If, Scotland having left, we then attempted to build back a single currency, it would mean even bigger economic costs for Scotland and the rest of the UK. The UK taxpayer would be in a more vulnerable position; all our standing with international markets would be less secure; and Scotland would pay a bigger price in terms of uncertainty, lost flexibility, more instability and more jobs lost.

    I do not want Scotland to leave the Union, but I am absolutely not going to say that if they did we would then do anything that made it worse. Attempting to have a single currency between a newly independent sovereign State called Scotland and the rest of the UK would make things worse, and we won't do it.[63]

43.  The choice of currency has major economic consequences for the future prosperity of Scotland and its people. The Scottish Government's preferred option of a currency union with the continuing UK would require an agreement to be negotiated between the Governments of a separate Scotland and the continuing UK. This has been categorically ruled out by the Chancellor of the Exchequer, the Chief Secretary to the Treasury and the Shadow Chancellor of the Exchequer. A separate Scotland cannot unilaterally impose a shared currency upon the UK and therefore we believe it is essential that the Scottish Government reconsider its position and make public its 'plan B' as a matter of urgency.

44.  Even if we leave aside the fact that a shared currency is not in the interests of the continuing UK it is equally clear that the Scottish Government's case for a currency union owes much more to politics than to economics. A formal currency union would mean that there would be substantial and ongoing restrictions on the Scottish Government's levels of Government borrowing and debt, and that Scotland would not have control over its own monetary policy. This is a very strange aspiration for the Scottish Government, which states that the most important decisions about the Scottish economy should be taken by the people of Scotland. This would clearly not be the case in the event of entering a formal currency union with the continuing UK.

45.  It is clear from the evidence that we have received, that the Scottish Government's proposal to maintain a currency union while undoing the necessary conditions of fiscal, banking and political union which sustain it, masks the fact that separation would be a hugely significant step that would have major adverse consequences for Scotland and its economy.

Unilateral use of Sterling

46.  In the event of a failure to agree a currency union, one option for the Scottish Government would be to continue to use sterling unilaterally-i.e. without a formal agreement with the rest of the UK. This is referred to as "sterlingisation". Based on statements made by Scottish Ministers that the United Kingdom "could not stop" Scotland from using sterling, this may indeed be the Scottish Government's "plan B".[64] There are examples of countries which have opted unilaterally to use another country's currency, for example, Panama which uses the US dollar (referred to as "dollarisation").[65]

47.  Adopting another country's currency is a policy often used by countries which have a poor economic record, [66] because linking to another more reputable currency is seen as a way of increasing economic credibility. In evidence to the Committee, Professor MacDonald said the unilateral use of the pound "for a country of Scotland's level of development, […] would certainly be very unusual". [67]

48.  The Chancellor of the Exchequer told us:

    I do not think it would be remotely possible for all the great companies that locate and headquarter in Scotland to remain there under the sterlingisation plan. I think there would be challenges for some of those companies to remain even under independence with different currency arrangements, but certainly under sterlingisation. It has never been tried in any economy of anything like the size and sophistication of the Scottish economy, or with anything like the established banking and financial services that Scotland has.[68]

49.  The unilateral use of sterling could create problems for Scotland's large financial services industry as it would mean no access to central bank services, such as the Bank of England's role as lender of last resort.[69] As Andrew Bailey, Chief Executive Officer of the Prudential Regulation Authority, explained, "when you come to areas like emergency lending, lending of last resort and anything of a capital nature, it is really the fiscal resources of the state that are being used".[70] Professor Macdonald said that it was "unlikely that financial markets would view that as a terribly credible regime for an independent Scotland".[71]

50.  The Shadow Chancellor of the Exchequer told us if Scotland were to go down the route of sterlingisation, "it would be very short-lived and would quickly end up with Scotland defaulting to its own currency".[72] He explained the needs of the financial system in Scotland would require the sovereign Government essentially to create a currency".[73]

51.  A separate Scotland could not be prevented from unilaterally adopting sterling. However, sterlingisation would have very serious consequences for Scotland's sophisticated financial services industry, and cannot be presented as being in Scotland's interest. While sterlingisation is therefore not a credible option, it appears to be the Scottish Government's current 'plan B'. We recommend that the Scottish Government should commission and publish work on what sterlingisation would mean in practice. Expert advice, together with the views of the banking and financial services industry, needs to be sought to clarify for Scottish voters the likely impact of any unilateral use of sterling.

Using the Euro

52.  Historically, adopting the Euro has been the preferred option of the SNP.[74] The recent problems in the Euro area have made this a less attractive option. John Swinney MSP, the Scottish Government's Finance Minister, said at present he could not "foresee circumstances in which a separate Scotland would want to join the Euro".[75]

53.  The potential economic consequences of adopting the Euro are varied and include: the one-off transitional costs related to the introduction of a new currency; an increase in the costs of trade with the continuing UK; lower costs for Scottish businesses trading with other members of the Eurozone; and a greater risk from a fluctuating exchange rate against the pound.[76] If a separate Scotland were to join the Euro, monetary policy would be determined by the European Central Bank (ECB). As the ECB sets interest rates for the Eurozone as a whole, and Scotland would be a small part of the Eurozone, Scottish economic conditions would have a limited influence on the ECB's decisions. This would increase the risk of interest rates being set at an inappropriate level for Scotland.

54.  The Scottish Government's Fiscal Commission Working Group has said Scotland's economy is less well aligned with the Eurozone than with the continuing UK.[77] Professor MacDonald told us: "if you are trying to remove the uncertainty of the effects of exchange rates on trade, you are probably better to do it in terms of the continuing UK".[78] When asked about the Euro serving many different economies, Professor MacDonald said:

    If you look at the eurozone, there certainly aren't any net oil exporters within the eurozone. I think I am correct in saying that. The only one that comes close, which has decided to stay outside, is Norway. For me, that would be another reason why you wouldn't want to join the eurozone; an independent Scotland would face these asymmetric shocks which would be very uncomfortable in a one-size-fits-all monetary union of that nature.[79]

55.  Dr Armstrong emphasised a different dimension on the issue of joining the Euro. He said:

    What the Euro area will be in the future could look very different from what it has been in the last 15 years, and, in that, there would be fiscal adjustments. Some of these problems of misalignment get dealt with; they are trying to go to this federal system. We don't know if they will get there yet, but if they did one day get there-it is not necessarily optimal because most of the trade is with the UK-maybe you would lose some of that gain from being with sterling, but you get a lot of other advantages. You would become an equal member in a big club and you are no longer next to a guy who is 10 times bigger than you. You are next to 19 other guys all with an equal vote. That is a different structure. Where we are today is a stab in the dark because we don't know what Europe is going to look like.[80]

56.  Countries wishing to join the Euro must meet a number of conditions, known as the convergence criteria. Based on the UK Government's existing levels of debt, the likely levels of debt Scotland would inherit, and the borrowing it would immediately have to undertake, it is unlikely that a newly separate Scottish State would meet the convergence criteria for Euro membership.[81] In addition to these formal requirements for Euro membership, countries which wish to join the Euro are required to become members of the European Exchange Rate Mechanism and ensure that the exchange rate between the currency and the Euro is stable for a period of two years so that the currency can be entered at the proper level. Unless Scotland chooses to have its own currency and join the Euro thereafter, it is hard to see how this condition can be met. The Scottish Government will be seeking membership of the EU, and it is likely that one of the conditions set, as for all other new Member States, would be a commitment to join the Euro. If the Scottish Government were to retain its policy of a currency union with the rest of the UK, it is not at all clear how it could give such a commitment in good faith in EU membership negotiations.

57.  In the event of separation, a new Scottish State would not be able to satisfy the conditions for membership of the Euro. However, given that a currency union with the continuing UK has been ruled out, a separate Scotland will have to consider seeking to join the Euro and may be obliged to make a commitment to do so as a condition of EU membership. The Scottish Government should therefore clearly set out how it would deal with this conundrum and indicate how and when the convergence criteria are likely to be met.

A separate Scottish currency

58.  A separate Scotland could decide to introduce its own currency. The main advantage of adopting an independent currency is that it gives Scotland an extra instrument of economic policy - a country with its own currency can adopt its own monetary and exchange rate policy which can help manage the economy. This policy could be tailored exclusively to economic conditions in Scotland. A Report by the Scottish Government's Fiscal Commission Working Group notes that Denmark, New Zealand, Singapore and Norway are all of a similar size to Scotland and all have their own currency.[82]

59.  However, there are also disadvantages to an independent currency. Establishing a new currency is a major undertaking, and the principal challenge is to ensure that users of the currency are willing to trust it as a store of value and a means of exchange. First, there would be the one-off costs of introducing the new currency-issuing new notes and coins and the costs of adjustment for households and businesses.[83] The scale of these costs is presently unknown. Second, an independent currency means greater transaction costs when trading with other countries as trade would require currency to be converted and a fluctuating exchange rate would mean greater risk for businesses. This would apply to trade both with the UK and with other countries.[84] Third, large currency fluctuations can cause economic instability. The UK Government has stated a view that a new currency could be at risk of a volatile exchange rate due to Scotland's large oil and gas sector, which would leave the Scottish economy exposed to the fluctuating prices of these commodities and to the unpredictable costs of extraction.[85] Professor MacDonald therefore concluded that it would be in best interest of the continuing UK for Scotland to have its own currency as "it will help to insulate the rest of the UK from bad shocks hitting Scotland".[86]

60.  However, a separate currency requires the State to adopt an exchange rate policy. A volatile exchange rate, especially in relation to the UK which is Scotland's biggest trading partner, could result in negative implications for trade. There may therefore be a case for an exchange rate to be fixed or 'pegged' to the pound. Certainly some small States with their own currency seek to keep the rate of exchange stable with a major anchor currency; for example, Denmark does this with the Euro. However, this acts as a major constraint on both fiscal and monetary policy. Currency reserves have to be built up to intervene in currency markets when necessary, and as Professor McDonald explained, monetary policy is driven by the need to keeping the exchange rate steady rather than by domestic economic policy needs:

    Another option that is currently widely discussed in the media is for an independent Scotland to issue its own currency, through say a newly established monetary authority, but peg the currency to sterling on a parity (one to one) basis. This would in all likelihood have to be set as a currency board arrangement along the lines of the Hong Kong currency board. However such a mechanism is set up it is a form of fixed exchange rate regime. To run and defend a fixed exchange rate regime against speculation you need to have huge foreign exchange reserves.[87]

61.  Despite the inherent risks involved, a new Scottish currency would give the Scottish Government the maximum economic leverage required to pursue a separate economic policy-the stated aim of separation. The Scottish Government should therefore explain why a separate currency is not its preferred option, and commission and publish new work on how, and at what cost, a separate currency could be created and the implications for Scotland's fiscal policy.

The best option?

62.  In summarising the currency options available, Dr Armstrong said clearly that "a non-credible currency proposal" should be avoided.[88] He described going into a referendum with a "currency proposal that nobody thinks is actually going to happen" as "a recipe for capital flight and for all sorts of difficulties".[89] On that basis, he identified a number of currency options:

    one type of currency union is the formal monetary union […] There are two problems. One is that you can't tie a country down, and the other is that one is so much bigger than the other it means that it is very difficult to negotiate. […] So you get to another type of currency union, which is the dollarisation or sterlingisation, […] or your own currency. Between those two, it depends on what could be negotiated around this sterlingisation system to make a hard choice, because you [could] have your own currency, which gives you a lot of economic sovereignty, but […] you have this very difficult transition period; or you [could] have this sterlingisation, which gives you very little economic sovereignty, but you could manage to put some adjustment factors in to make this easier. It then becomes a choice between those two. My view is that it is no surprise, when you look around the world and see countries the same size of Scotland, with the same sort of wealth as Scotland, that they have their own currency.[90]

He concluded that "the worst option is where people are just left with complete uncertainty".[91] Professor MacDonald agreed:

    There is only one currency option that the economics of currencies suggests will be credible to financial markets and that is an independent currency. That, however, may come at considerable cost and disruption to Scotland in any transition period. But then it would be remiss of an economist not to point out that just as in life so to in currency matters: there is no such thing as a free lunch![92]

63.  In considering all the advantages and disadvantages of the potential currency options for a separate Scotland, it is clear beyond all doubt that none of the options is as good for Scotland as remaining in the UK, as part of the existing formal currency union as currently configured within the UK state.

7   Q 358 Back

8   "Scots can be sterling squatters", Financial Times, 8 April 2014 Back

9   "Economic aspects of Scottish independence: currency", House of Commons Library, Standard Note EP/6685, 26 February 2014 Back

10   Ibid.  Back

11   Ibid.  Back

12   Ibid.  Back

13   Ibid.  Back

14   Scottish Government, Scotland's Future - Your Guide to an Independent Scotland, November 2013 Back

15   HM Government, Scotland Analysis: Financial services and banking, May 2013 Back

16   Fiscal Commission Working Group, First Report - Macroeconomic Framework, February 2013 Back

17   Scottish Government, Scotland's Future - Your Guide to an Independent Scotland, November 2013 Back

18 Back

19   Ibid.  Back

20   HM Government, Scotland analysis: Currency and monetary policy, April 2013 Back

21 Back

22 Back

23   Q 4474 Back

24   Scottish Government, Scotland's Future - Your Guide to an Independent Scotland, November 2013 Back

25   Ibid.  Back

26   HM Government, Scotland Analysis: Currency and monetary policy, April 2013 Back

27 Back

28   HM Government, Scotland Analysis: Financial services and banking, May 2013 Back

29   Ibid.  Back

30   "The Economic Implications for the United Kingdom of Scottish Independence", House of Lords Economic Affairs Committee, 10 April 2013 Back

31   Ibid.  Back

32   Scottish Government, Scotland's Economy: the case for independence, May 2013 Back

33   HM Government, Scotland Analysis: Currency and monetary policy, April 2013 Back

34   Q 4509 Back

35   Q 4509 Back

36   Q 4488 Back

37   Ibid.  Back

38   Ibid.  Back

39   Ibid.  Back

40   Q 4490 Back

41   HM Government, Scotland Analysis: Currency and monetary policy, April 2013 Back

42   Q 4490 Back

43   First Minister Alex Salmond speech, Edinburgh, 17 February 2014 Back

44   Q5799 Back

45   Q 5683 Back

46   First Minister Alex Salmond speech, Edinburgh, 17 February 2014  Back

47   Q 5799 Back

48   George Osborne, Speech on the prospect of a currency union between an independent Scotland and the rest of the UK, 13 February 2014 Back

49   "Ed Balls: Currency union with Scots 'won't happen'", The Scotsman, 13 February 2014 Back

50   "For Scotland, separation would be the riskiest step our country has ever taken", 13 February 2014 Back

I 51  ndependent Scotland 'may keep pound' to ensure stability", Guardian, 29 March 2014 Back

" 52  Independent Scotland 'may keep pound' to ensure stability", Guardian, 29 March 2014 Back

A 53  lex Salmond pressurises Mark Carney over pound", The Telegraph, 29 January 2014 Back

54   Q 5696 Back

55 Back

56   Q 5722 Back

57   Q5617 Back

58   Q 5739 Back

59   Q 5753 Back

60   Q 5722 Back

61   Q 5691 Back

62   Q 5628 Back

63   Q 5790 Back

64   "Alex Salmond's hints at Plan B on currency: using sterling regardless", The Guardian, 25 February 2014 Back

65   Q 4476 Back

66   John Kay, "Scots who want to leave the UK must be ready to drop sterling", Financial Times, 24 April 2013 Back

67   Q 4514 Back

68   Q 5737 Back

69   "The Economic Implications for the United Kingdom of Scottish Independence", House of Lords Economic Affairs Committee, 10 April 2013 Back

70   Q 4793 Back

71   Q 4516 Back

72   Q 5763 Back

73   Q 5768 Back

74   "The Economic Implications for the United Kingdom of Scottish Independence", House of Lords Economic Affairs Committee, 10 April 2013 Back

75   Ibid.  Back

76   "Economic aspects of Scottish independence: currency", House of Commons Library, 26 February 2014 Back

77   Fiscal Commission Working Group, First Report - Macroeconomic Framework, February 2013 Back

78   Q 4532 Back

79   Q 4534 Back

80   Q 4534 Back

81   "Economic aspects of Scottish independence: currency", House of Commons Library, Standard Note EP/6685, 26 February 2014 Back

82   Fiscal Commission Working Group, First Report - Macroeconomic Framework, February 2013 Back

83   HM Government, Scotland Analysis: Currency and monetary policy, April 2013 Back

84   Ibid. Back

85   Ibid. Back

86   Q 4571 Back

87 Back

88   Q 4567 Back

89   Ibid.  Back

90   Ibid.  Back

91   Q 4569 Back

92 Back

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Prepared 21 July 2014