By Richard Johnstone | 9 May 2014
A currency union between an independent Scotland and the rest of the UK is unlikely to include either a fiscal pact or a banking union as these would be worthless and unsustainable in the long term, a study has concluded.
The National Institute of Economic and Social Research examined the Scottish Government’s preferred currency union policy and found that any negotiation to form a monetary union would result in a currency arrangement that resembles ‘dollarisation’ – the process by which Panama uses the US dollar without any say in monetary policy.
NIESR’s director of macroeconomic research Angus Armstrong and research fellow Monique Ebell concluded that because the two states would be substantially different in size, it would not be in the interest of either to sign up to either public spending limits or mutual support for banking systems.
According to the preferred policy of the Scottish Government, an independent Scotland would have one representative on the Monetary Policy Committee, compared to eight for the rest of the UK.
This means the rest of the UK would dominate decisions and Scotland would have no effective influence on policy.
Therefore, the Scottish Government’s borrowing decisions would not directly influence monetary policy in a ‘Sterlingzone’, removing the rationale an independent Scotland to abide by constrains in any fiscal pact.
As restrictions could not be practically enforced, any UK government agreement to such a regime ‘may invite the perception of culpability by the UK and therefore an expectation of a bail-out if necessary’, NIESR concluded, so it would not be in the interests of the rest of the UK.
In addition, a banking union between an independent Scotland and the rest of the UK would not be sustainable as – in the event of a banking crisis south of the border – the size of a potential fiscal transfer from Scotland could be so large to outweigh the benefits of remaining in the agreement. An independent Scotland would therefore have no incentive to participate, the Monetary unions and fiscal constraints paper, published in the National Institute Economic Review, concluded.
Given what the authors called the lack of economic rationale to these cross-border agreements, any deal to create them would be seen to be worthless.
‘NIESR’s research challenges the conventional wisdom, held by the UK and Scottish Governments, on the desirability of fiscal constraints and a banking union to underpin a monetary union between an independent Scotland and the rest of the UK,’ the report stated.
‘Monetary union without fiscal constraints and a banking union would resemble so-called ‘dollarisation’. This would be a deliverable outcome by two sovereign countries negotiating in their self interest, but whether it would be a stable currency regime is an entirely separate question.’
The authors highlighted that, in their earlier research, they had argued ‘dollarisation’ in a country with a large public sector debt burden was unlikely to be a stable currency regime.
