Scotland's future currency

1st Aug 2014

  • An independent Scotland would have four main options for a currency: keeping the pound in a currency union with the UK, keeping the pound informally without a union, adopting the Euro or introducing a new Scottish currency.
  • The Scottish government wants to keep the pound through a negotiated agreement with the rest of the UK. They'd leave it open to people in Scotland to choose a different arrangement in future.
  • The UK government, as well as all three main parties, reject this and say they will not negotiate. The Scottish government has not stated what it would do if no agreement can be reached.

"The choice of currency is perhaps the most important economic decision an independent Scottish government would face."

House of Lords Economic Affairs Select Committee

Option 1: Keep the pound in a formal currency union

  • Needs agreement with the UK, especially over Bank of England structure. Gives away some economic powers to the UK, but no costs of changing currency.

Both sides agree this would need agreement and cooperation between Scotland and the rest of the UK - and this is a big sticking point. Scotland would keep the pound but would lose the ability to set its own interest rate, which would continue to be set by the Bank of England.

The Scottish government wants Scotland to be a shareholder of the Bank and have a role in overseeing its operations. However the House of Lords Economic Affairs Committee  says this is "devoid of precedent and entirely fanciful", and views it as unlikely that the UK government would agree.

The Fiscal Commission Working Group - which advises the Scottish government - admits a currency union means giving up flexibility on economic policy: there would have to be one interest rate and exchange rate for the union, very much like the current situation. On the plus side, it means reduced trade costs than would otherwise be the case.

All three major UK parties have ruled out this option. This led the House of Commons Scottish Affairs Committee to conclude:

"If Scotland leaves the United Kingdom there will not be a currency union" ...

"[the parties] have been so unequivocal as to leave themselves without any room for manoeuvre".

The Scottish government's proposals include the admission that people in Scotland "could choose a different arrangement in future". This is a key concern for the UK government, which says that uncertainty over the permanence of a currency union could lead financial markets to put 'speculative pressure' on the arrangement.

Option 2: Keep the pound unilaterally, without formal agreement

  • No agreement needed, but no control over interest rates or exchange rates either, and no central bank as lender of last resort.

This option, known as 'sterlingisation' or a form of 'dollarisation', would mean Scotland continues to use the pound but has no access to or influence over the Bank of England, so it couldn't control its interest rates or act as a lender of last resort to Scotland's financial services sector.

Panama currently uses the US dollar in the same way, and Montenegro uses the Euro likewise.

The economist John Kay (£) says there is nothing to stop Scotland 'sterling squatting'.:

"In today's world of global business and finance, people make agreements in whatever currency they like and under whatever legal system they choose."

Professor Jim Gallagher of Nuffield College, Oxford, warns that this is "not a viable option" for a country with a large financial services sector:

"What you might call the Montenegro option of dollarisation is open to anyone, but it is open to anyone who wishes to operate without a sophisticated financial system."

Think tank Adam Smith Institute has said there could be merits to an adaptation of this option:

"An independent Scotland using the pound outside of a currency union would have a more stable financial system and economy than it has now or than a currency union could provide".

For example, it says that evidence from Latin American countries suggest that some of the constraints of 'sterlingisation' force banks to be more cautious and so remove "moral hazard" from the system.

Option 3: Adopt the Euro

  • Technically part of requirement to join the EU, although not clear whether Scotland will be have to or be able to in practice. Costs to changing currency, and could lead to inappropriate interest rates for Scotland, set by European Central Bank.

Scotland could apply to join the European Monetary Union, according to the Fiscal Commission Working Group, which would mean the European Central Bank would control interest and exchange rates.

But it would need to meet a series of economic requirements - called 'convergence criteria' - to ensure they don't diverge too much from other member states (such as having too big a debt or deficit).

It's difficult at the moment to estimate whether Scotland will meet these criteria. Most available figures apply to the UK as a whole, and Scotland's actual share of things like spending and public debt will need to be determined by negotiation following a yes vote.

Scottish Finance Minister John Swinney has all but ruled out this option for the immediate future:

"I cannot foresee circumstances in which an independent Scotland would want to join the euro."

There's an additional dispute between the UK and Scottish governments over whether Scotland would even have the choice to avoid the euro if they became an EU member state. The UK government says it would have to join the Euro, the Scottish government says not.

For Scotland to avoid this, it could either negotiate a specific opt-out like the UK and Denmark enjoy, or deliberately seek not to meet the eligibility requirements, for instance by not joining the Exchange Rate Mechanism. Participation in the mechanism is voluntary for those without the euro, though Member States without a specific "opt-out" and who haven't yet met the eligibility requirements "can be expected to join the mechanism". In practice this isn't always the case - for example Sweden doesn't use the euro for this reason.

Option 4: Introduce a new Scottish currency

  • Gives Scotland maximum flexibility over economic policy, but costs to changing currency and a number of practical difficulties.

This in itself could work in a number of different ways. For instance, a new currency could be kept at a fixed rate to the pound, or it could be left to 'float' of its own accord. A new Scottish currency would mean new institutions - mainly a central bank like the Bank of England.

While this option would give Scotland "maximum policy flexibility", according to the Fiscal Commission Working Group, it isn't favoured by the Scottish government because of the costs involved.

For instance, new notes and coins would need to be issued, and the old ones withdrawn. Contracts would need to be rewritten in the new currency, and there may be additional barriers to trade.