Scotland after sterling

BERKELEY — The odds of Scotland becoming independent are rising by the day. In Scotland’s 2014 referendum, some 45 per cent of voters favored independence. Brexit, which some 60 per cent of Scotland’s voters opposed, is now forcing the Scottish electorate to choose between staying in the United Kingdom and remaining in the European Union, shifting public opinion further towards independence.

Prime Minister Boris Johnson’s shambolic EU trade negotiations heighten that dilemma. Reflecting such pressures, pro-independence sentiment has exceeded 50 per cent in six polls conducted this year.

But if you think the UK’s negotiations with the EU are fraught, just wait for its negotiations with Scotland. Should income from North Sea oil be apportioned on a per capita basis or geographically, akin to fishing rights? Should responsibility for servicing the UK’s national debt be assigned as a function of relative national incomes or populations?

Then there are currency arrangements. One might think that this is not an issue for international negotiation. Many will assume that an independent Scotland should have its own currency, managed by its own central bank.

But another recent poll found 40 per cent of Scots describing themselves as “less likely” to vote for independence if this meant replacing the pound. Admittedly, the poll was commissioned by a pro-UK lobby, Scotland in Union. Still, the result is indicative of the discomfort many Scots feel about forsaking sterling for an uncertain successor.

A decade ago, pro-independence Scots sought a monetary union with a rump UK. Scotland would then continue to receive the lender-of-last-resort services and reputational benefits of association with the Bank of England. But the UK government quickly put the kibosh on that idea. Anyway, this possibility has been rendered moot by Brexit, because an independent Scotland that was already in a monetary union with an extra-EU country would be unable to rejoin the EU.

Some have suggested that Scotland should create a new currency and peg it firmly to the pound in the manner of a currency board. This arrangement, the advocates argue, would ensure currency stability vis-à-vis the UK, but also enable Scotland to rejoin the EU. After a suitable period, it would replace its currency with the euro.

In the meantime, however, Scotland would have zero say over the level of interest rates prevailing in the country. It would possess no lender of last resort. And whether it could qualify for eurozone membership is unclear. One of the convergence criteria governing admission is holding one’s currency stable against the euro for two years. Holding the exchange rate stable against the euro while also pegging it to the pound would be a neat trick.

This leaves only the option of a new national currency managed by an independent central bank that sets policy in accordance with a mandate to ensure price stability. But, as recent years have shown, inflation targeting is at best a work in progress. With central banks repeatedly missing their targets, policymakers have been unable to convince the public and investors that their aim is true. Moreover, central bank independence will be hard to establish in a politically charged environment where there already are calls to put all manner of special interests on the new entity’s board.

Still, the combination of central bank independence and inflation targeting is the least bad alternative. Sweden’s experience shows that it can provide monetary stability for a small EU member that has not adopted the euro. Of course, this assumes a high level of fiscal discipline, something that Sweden, but not yet Scotland, has effectively demonstrated.

In any case, what is a permanent state for Sweden will presumably be a temporary phase for Scotland, which is unlikely to be able to negotiate an opt-out from the euro. But this should not be a deal breaker. Membership in the eurozone looks like a safe option, given the banking union, the European Central Bank’s acknowledgment of its lender-of-last-resort responsibilities, and the EU’s progress in creating a common fiscal capacity.

The first step, establishing a new Scottish currency, will not be easy. It will be necessary not just to print banknotes but also to reprogram the banks’ computers and convert corporate and government accounts. Automatic tellers and parking garage pay stations will have to be retrofitted. It’s worth recalling that it took two full years to complete the changeover from Europe’s legacy currencies to the euro. A credible plan for Scotland would require policymakers to start preparing now.

None of this means that independence won’t happen. I know from having lived there, a while ago, admittedly, that Scottish identity is strong. Independence referenda turn on more than just economics, as the UK’s Brexit vote itself amply demonstrates.

But Scotland needs a plan for a new currency and an independent central bank, as well as a blueprint for its subsequent transition to the euro. These would go a long way towards reassuring Scots who yearn for independence but worry about what follows sterling.

Barry Eichengreen is professor of Economics at the University of California, Berkeley. His latest book is “The Populist Temptation: Economic Grievance and Political Reaction in the Modern Era”. Copyright: Project Syndicate, 2020. 

www.project-syndicate.org