Economic Implications for the United Kingdom of Scottish Independence - Economic Affairs Committee Contents


The currency choice facing Scotland can be summarised by three basic options: one is the pound sterling; another is an independent Scottish pound; and the other the euro.[193] Ms Ruth Davidson MSP reminded us that over the last 25 years the Scottish National Party has preferred each of the three options at different points in time.[194] Moreover, there is no reason to suppose that the currency chosen immediately upon gaining independence would be the permanent choice of currency thereafter. For example, the Fiscal Commission Working Group leaves open the possibility of moving to an independent currency at some stage in the future. Also governments of the euro zone are making some fundamental changes to how they operate which may, in time, make it a more or less attractive proposition. These alternative currency arrangements are considered below.

An independent Scottish pound

An obvious option for an independent Scotland would be to introduce a new currency or Scottish pound. Professor John Kay of Oxford University pointed out that one of the obvious marks of independence is that you have an independent currency.[195] This is not simply emblematic but can avoid many of the constraints on economic policy which follow from the other currency options. In this sense, only an independent currency is full independence.

There are several countries in Europe with a similar size population and level of wealth to Scotland which operate perfectly successfully with their own currency. A Scottish pound would require a new Scottish central bank to issue the currency, to oversee the financial system and to conduct monetary policy on behalf of the Scottish Government. An advantage of this arrangement is that having an independent central bank and independent currency would achieve two of the three necessary conditions if Scotland wishes to join the euro zone at some time in the future.

Having an independent currency inevitably involves trade-offs. On the one hand an independent currency gives a government the greatest scope for monetary and fiscal policy to be tailored for local circumstances.

On the other hand an independent currency leads to transaction costs not simply the percentage taken by the money changers but the much greater costs in dealing with the uncertainty of a variable exchange rate. This would make planning more difficult and expensive, particularly for businesses conducting their affairs across the border and those travelling across the border. The costs of managing the exchange rate risk would be a direct burden on businesses in Scotland and the rest of the UK. Movements in the exchange rate would also lead to changes in relative wealth between those living north and south of the border.

To avoid some of the costs arising from exchange rate volatility the Scottish pound might be pegged to sterling.[196] If the Scottish pound were to be pegged to sterling the monetary policy of the Scottish central bank would need to closely follow the Bank of England's policy, thus losing one policy lever and undermining the reason for introducing the new currency in the first place. There would continue to be a greater degree of freedom for setting fiscal policy although in practice this would depend on the level of debt of an independent Scottish government.

Many witnesses drew the comparison to the progression of currency arrangements in Ireland after the Anglo-Irish Treaty in 1921 and possible currency choices for Scotland. Sterling continued as the currency in Ireland until 1928 when the Irish punt was introduced. This was managed by a currency commission (or currency board) until the central bank was set up in 1942. The punt remained linked to sterling and the central bank operated as a de facto currency board policy until joining the European Exchange Rate Mechanism in 1979.[197] The punt then depreciated several times within the ERM and fluctuated significantly against sterling.[198]

Until 1979 both currencies circulated interchangeably in Ireland but "it was hard to get a cab driver in London to accept an Irish punt".[199] Professor Gerald Holtham, Chairman of the Independent Commission on Funding and Finance for Wales, explained that if an independent Scotland were to set up a currency board then "you are importing your monetary policy from England effectively but you do not have a lender of last resort and, to that extent, your financial institutions may be regarded as more vulnerable and you may have to pay higher interest rates for your debt".[200] Professor Gavin McCrone described how the Irish Government's fiscal policy was very tightly constrained by the need to maintain the currency link.[201]

If an independent Scotland were to introduce a Scottish pound perhaps the greatest problem would be the transition from the current to the new regime. Those in Scotland would take a view as to the likely long term value of the Scottish pound and sterling. Capital movement in either direction in anticipation of the new currency could make the initial transition very challenging.

When choosing across the currency options the pros and cons of creating a new currency must be weighed against those of the other currency options. Professor Kay suggested that if one is pushed towards a new currency it is mainly because in the present circumstances it might be quite difficult to negotiate what would plainly be the best arrangement from Scotland's perspective, which would see the Bank of England continuing to be the monetary authority for both Scotland and England, with a substantive monetary union between the two independent nations.[202] A monetary union may of course undermine much of the raison d'être for independence in the first place.

The euro

The Scottish Government has stated that an independent Scotland would seek to join the EU. All nations in the EU are required to join the euro with the exception of the UK and Denmark who negotiated opt-out clauses. This may not bind Scotland to any fixed timetable for euro zone membership but a clear commitment to joining would be required as there is no reason to believe that an opt-out would be negotiable.

Mr John Swinney MSP, Cabinet Secretary for Finance, Employment and Sustainable Growth in the Scottish Government has stated that he "cannot foresee circumstances in which an independent Scotland would want to join the euro."[203] In the near term this is likely to be the case. The third requirement for joining the euro (along with an independent currency and a central bank) is meeting the so-called convergence criteria or Maastricht criteria. On any reasonable division of assets and liabilities it seems unlikely that an independent Scotland would, according to Professor Kay, meet the:

    "criteria on the kind of envelope numbers one would have from an independent Scotland, so that would not arise as an immediate issue. I also suspect there is a lot less inclination on the part of people in Europe to bend the rules in favour of letting additional countries into Europe now."[204]

The structure of the European Monetary Union is however changing significantly. There are clear plans to move towards closer political and fiscal integration with a single bank regulator and possibly a common deposit insurance scheme. If Scotland were eventually to join the euro zone it would have a seat on the European Central Bank by right and have an equal vote with all other members. This would avoid the difficult governance issues with the UK government over the Bank of England which would arise if Scotland keeps sterling as its currency. Over time euro zone arrangements may become more agreeable than the alternative choices.

Professor McCrone raised doubts about whether an independent Scotland could maintain its competitiveness within the euro zone:

    "Monetary unions only work if inflation is at broadly comparable rates between the member states … Countries with their own currencies can restore competitiveness by devaluation, but within the euro zone this is impossible … Certainly Scotland would be wise not to join the euro, at least if there is any doubt at all about its ability to maintain the competitive position of its economy against other euro zone countries."[205]

However, the case of Ireland may yet show that realigning competitive positions may in fact be possible, albeit at some price.

193   Q 67 Back

194   Q 588 Back

195   Q 69 Back

196   ibidBack

197   Patrick Honohan, Currency Board or Central Bank? Lessons from the Irish Pound's Link with Sterling, 1928-79  Back

198   Gavin McCrone, Matter of no small change, The Scotsman 28 February 2012 Back

199   Q 71 Back

200   Q 344 Back

201   Gavin McCrone, Matter of no small change, The Scotsman 28 February 2012 Back

202   Q 69 Back

203   Q 887 Back

204   Q 67 Back

205   Gavin McCrone, Matter of no small change, The Scotsman 28 February 2012 Back

previous page contents

© Parliamentary copyright 2013