Bank of England Governor Mark Carney says an independent Scotland would have to cede some of its national sovereignty if it wants to keep the pound.
He said the Scottish government needed to “consider carefully what the economics of currency unions suggest are the necessary foundations for a durable union, particularly given the clear risks if these foundations are not in place”.
He added: “Those risks have been demonstrated clearly in the euro area over recent years, with sovereign debt crises, financial fragmentation and large divergences in economic performance.
“The euro area is now beginning to rectify its institutional shortcomings, but further, very significant steps must be taken to expand the sharing of risks and pooling of fiscal resources.
“In short, a durable, successful currency union requires some ceding of national sovereignty. It is likely that similar institutional arrangements would be necessary to support a monetary union between an independent Scotland and the rest of the UK.”
Mr Carney met Scotland’s First Minister, and Scottish National Party leader, Alex Salmond for talks before his speech – the first time the two have had face-to-face discussions since he took over as Bank of England governor in July 2013.
The Scottish government has already put forward plans for Scotland to retain the pound if the country votes for independence in September’s referendum. It argues that this would also be in England’s interests.
Chancellor George Osborne has cast doubt on whether this would be achievable, saying it is unlikely the UK government would back it.
David Cameron’s official spokesman echoed this on Wednesday, saying “it is highly unlikely that the UK would want to enter into a currency union in the event of an independent Scotland”.
Mark Carney said currency unions needed banking unions and “shared fiscal arrangements” because “problems in one country are very likely to spill over to others”.
The threat of default by one country could trigger a crisis, he said, “particularly if the liabilities of the crisis country are held by the banking system of the broader currency area”.
He added: “It will be in the interests of other countries in the union to bail out a country in crisis, and that reduces the incentives for countries to run their finances prudently in the first place.
“At a minimum, this ‘moral hazard’ problem suggests the need for tight fiscal rules, to enforce prudent behaviour for all in the union, although credible sanctions for breaking those rules are hard to develop.”
Alistair Darling, leader of Better Together, which opposes independence, said: “There is one clear message from today’s thoughtful speech by Mark Carney, the governor of the Bank of England – that the failings of the eurozone show that to have a successful monetary union you require fiscal and political union.
“This is a detailed speech but make no mistake, the governor’s judgement on currency unions is devastating for Alex Salmond’s currency plans. Why? Because the whole point of independence is to break the fiscal and political union that makes monetary union possible.”
Mr Salmond said after his talks with Mr Carney that the governor had agreed to continue discussions about a shared currency zone.
“The discussion was private, but I welcome that the governor has confirmed his willingness to continue technical discussions, inaugurated by his predecessor (Sir Mervyn) King, between the Scottish government and the Bank of England in advance of the referendum,” he said in a statement.
Mr Salmond said on Tuesday that Sir Mervyn King had told him the Treasury could change its approach to a currency union if Scotland voted for independence.
The first minister said he met Sir Mervyn “a couple of years back”, adding: “The first thing he said to me was, ‘Your problem is what they say now, meaning the Treasury. ‘and what they say the day after a yes vote in the referendum are two entirely different things’.”
The Scottish government says an independent Scotland would retain the pound, but the UK government says it is highly unlilkely it would agree to share its currency. So what would happen if Scotland was forced to go its own way?
When Czechoslovakia broke up into the Czech Republic and Slovakia on 1 January 1993, the plan was to maintain a common currency, but this did not work out. Slovaks, believing a split was inevitable, began depositing their money in the Czech Republic because of its stronger economy. The outflow of cash from Slovakia became so serious that the leaders of both countries conducted secret negotiations to split the currencies as early as mid-January.
On 2 February, in a surprise announcement, politicians in both countries told their citizens the currency union would end six days later, marking the end of the Czechoslovak crown and the beginning of two separate currencies, the Czech crown and the Slovak crown.The next day, all payments between the two republics stopped, capital controls were tightened and border controls were stepped up to prevent cash transfers between the two countries.
Over the next few days – Thursday to Sunday – the old Czechoslovak currency was exchanged for the new currencies, which became legal tender on 8 February.To save time, old Czechoslovak notes were stamped with either Czech or Slovak identification to mark them as the separate currencies. A cloak and dagger operation had ensured secrecy, with the stamps pre-printed in Latin America and shipped in secret.
Hundreds of millions of notes were stamped, with state employees kept in the dark about what they were doing. The army and pooice were involved and helicopters used to transport the cash. Later that year, as the Slovaks had feared, the Slovak crown was devalued. But, in the longer term, the split and the autonomy it provided worked out well for both countries, which experienced growth during the 1990s.