In its White Paper, Scotland’s Future, the Scottish Government proposes retaining the pound and establishing a formal currency union with the rest of the UK (rUK) after a Yes vote -  rather than joining the Euro or establishing a new currency. It does note though that ‘people in Scotland’ could ‘choose a different arrangement in the future’. It argues that a shared currency would be in the economic interest of both Scotland and rUK given the high amount of trade, jobs and company operations that flow across the border between Scotland and rUK. Likewise, and for the same reasons, Scotland leaving the pound would be damaging for both economies.

The Scottish Government envisages the Bank of England remaining as Scotland’s central bank. The Bank would continue to give guarantees to the Scottish banking system in case of any future crisis. Scotland would have a role in running the Bank through shared ownership and governance arrangements.

The Scottish Government also envisages a ‘fiscal sustainability agreement’ between Scotland and rUK. This would set rules on the limits of overall government debt and annual spending deficits for both countries. Within the limits of that agreement an independent Scottish government would be able to use its powers on taxes, spending and borrowing in the interests of the Scottish economy.

In its paper on currency union, the UK Government describes the UK as 'one of the most successful monetary, fiscal and political unions in history'. It says this success comes from the coordination of economic policies which allows risks to be shared across the UK. This success would be difficult to maintain if the pound were shared between rUK and Scotland in a currency union.

The UK Government argues that Scotland would introduce different economic policies after independence. And there could be changes in industries like oil and finance, which have a much greater impact on Scotland’s economy than they do in the UK as a whole. The UK Government argues that if the pound were shared, it would need to monitor Scotland’s taxes and spending and ‘intervene’ if it thought Scottish policies put the stability of the currency union at risk. This would limit what Scotland could do with its powers as an independent country.

It argues that any arrangements for the Bank of England to give guarantees to banks in Scotland and rUK would be unbalanced. Because rUK would be so much bigger than an independent Scotland taxpayers in rUK might well be able to support Scottish banks through a future crisis. But the far smaller number of Scottish taxpayers could not provide the same support in a crisis in rUK banking.

The UK Government questions the long-term commitment of an independent Scotland to currency union, noting the comment in Scotland’s Future that Scotland could ‘choose a different arrangement in the future’.

For these reasons the Scotland Analysis paper advises against formal currency union. This advice was accepted in statements by both government and opposition at Westminster that currency union ‘is not going to happen’.

The two governments’ positions on currency union are very different.

The Scottish Government emphasises the many interactions between the Scottish and rUK economies to argue that formal currency union would be in both countries’ interests. It envisages shared governance of currency union including negotiated limits on debt and spending agreed by both countries.

The UK Government emphasises the likely growth of differences in the two economies and their differences in size. These would leave rUK facing greater risk in a formal currency union than would Scotland. It does not envisage the Bank of England as a jointly run body after Scottish independence, but one which would serve rUK alone.

The statements by leading figures in UK government and opposition that a formal currency union ‘is not going to happen’ sound definitive. Yet the Scottish Government has suggested this is a negotiating position which would change in the event of a Yes vote. It is clear that a post-Yes negotiation would be complex, involving discussion and, possibly, trade-offs across different fields. If the UK
Government did in the end negotiate on currency union it would likely drive a hard bargain on any fiscal sustainability agreement. This could propose tough limits on Scottish taxes and spending that could be difficult for the Scottish Government to accept.

If that were the case – or if the UK Government refused to negotiate at all – then the most obvious ‘Plan B’ would be for Scotland to continue to use the pound, but informally, without any input into Bank of England policies and without the Bank acting as lender of last resort.

Charlie Jeffery, July 2014