“There is a very, very powerful argument (for Scotland to retain the pound)”
Scotland’s First Minister Alex Salmond, launching Scotland’s White Paper for independence, 26 November 2013
Not too long ago, Scotland’s first minister said there was a “very strong” argument for Scotland to abandon the pound and join the euro.
In an interview in 2009, Alex Salmond reportedly chuckled to himself as he told a Spanish reporter: “Sterling is sinking like a stone.”
The Scottish National Party (SNP), according to Salmond’s senior adviser at the time, had “always recognised the benefits of euro membership”.
Yet today, there was no question of handing over Scotland’s financial and economic affairs to Brussels.
Launching the Scottish government’s blueprint for an independent Scotland he declared: “We have no wish to join the euro”. Nor does the government wish to set up Scotland’s own currency.
Instead, the SNP favours sterling. Indeed, the white paper states that “the pound is Scotland’s currency just as much as it is the rest of the UK’s”.
But if that’s true, then why all the talk of “retaining” the pound – and why did Mr Salmond mention needing “acceptance” from the UK government?
An independent Scotland can technically choose whatever currency it wants. It does not need permission from the Bank of England to use pounds.
From an admin point of view, keeping the pound – rather than introducing euros or a new Scottish currency – would keep transition and transaction costs down.
But choosing a currency is “perhaps the most important economic decision an independent Scottish government would face”, the House of Lords economic affairs committee has previously said.
It has wide-ranging economic implications: it affects trade, government spending and tax and interest rates.
The SNP’s white paper concluded that continuing with the use of sterling would be “the best option”, as part of a “formal monetary union with [the] rest of the UK”.
It adds: “The commission’s analysis shows that it will not only be in Scotland’s interest to retain sterling but that – post independence – this will also benefit the rest of the UK.”
The commission refers to the Fiscal Commission Working Group, a team of economic advisers, including two Nobel laureates, appointed by the Scottish government.
The benefits are listed as trade, business, labour and productivity.
The UK government however, isn’t convinced. It has said previously that the economic rationale for the UK to enter a formal sterling union “is not clear”.
Hinting at recent crises in the eurozone, Danny Alexander, chief secretary to the Treasury, said that 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”.
Perhaps that’s why Mr Salmond no longer favours the eurozone and instead favours a “sterling zone”. Certainly, the National Institute of Economic and Social Research (NIESR) argues that the pound offers “perhaps the greatest possibility of financial stability” for Scotland.
That said, NEISR argues that a separate currency would be the most “prudent option” for an independent Scotland. A Scottish currency might have high transaction costs and offer little financial backup, but it also offers the greatest degree of flexibility in monetary, exchange rate and fiscal policy terms, the group said.
There would be very little flexibility with the pound. As a House of Commons library paper points out, if an independent Scotland wants to form a monetary union with the UK – to use the pound as part of a “sterling zone” – it would have to negotiate with Westminster the level of debt and borrowing an independent Scotland would be allowed to have.
It would also be subject to a single official interest rate for the whole sterling area, set by the Bank of England.
Fundamentally, as the HoC library paper states, under a formal currency agreement: “Scotland would not be able to operate its own, independent monetary policy.”
Scotland’s white paper itself concedes: “After independence, monetary policy would be set by the Bank of England”.
Despite this, the SNP claims it has a “shareholder” interest in the Bank of England and as such would seek “formal input into the governance and remit” of the bank.
At one point the white paper states that the Bank of England would be “accountable to both countries”.
Yet NEISR points out that given the UK population is 10 times bigger than Scotland’s, “it is unclear how this would result in shared responsibility”.
The House of Lords economic affairs committee went further, stating that “it would be unacceptable for the MPC to have members representing the interests of a separate country”.
It described the proposal that the Scottish government should have some say over governance of the Bank of England as “devoid of precedent” and “entirely fanciful”.
Meanwhile, NEISR says the much bigger issue is the role the bank would play in supporting Scotland’s financial stability. As the central bank, the BoE would traditionally act as a “lender of last resort” – providing liquidity.
However the UK government has said an agreement would need to be reached on crisis procedures which “would be a lot more complex with two governments and one central bank”.
The Lords said it was “implausible” that the BoE would accept such risks.
There’s nothing stopping an independent Scotland continuing in its use of sterling. But the implications of that are huge.
In order to use sterling, an independent Scotland would have to accept limits on its budget deficit and government debt.
The UK government has said that a negotiated agreement “would be likely to include rigorous oversight of Scotland’s economic and fiscal plans by the UK authorities”.
What’s more, by entering a “sterling zone”, Scotland would forfeit the ability to set its own interest rate. That would be set by the Bank of England.
The white paper itself admits this – stating that an if independent Scotland retained the pound, it would have its monetary policy “set by the Bank of England”.
The paper also sets out how the bank would “retain its remit for financial stability”, as well as continuing “to set macro prudential policy and identify systemic risks across the whole of the sterling area”.
In other words, the Bank of England’s MPC would be in charge of regulating the financial system as a whole and would continue to be responsible for financial stability.
Scotland’s deputy first minister Nicola Sturgeon stood by Mr Salmond’s side today, insisting that: “Scotland’s future is now in Scotland’s hands”.
Yet this white paper just puts Scotland’s economic future into the hands of the Bank of England.
By Emma Thelwell