National Institute of Economic and Social Research at the Royal Economic Society
Scottish Independence and its Macroeconomic Framework
The National Institute of Economic and Social Research are hosting a Special Session on Scottish Independence and the Macroeconomic Framework at the Royal Economic Society's 2014 Annual Conference on Tuesday 8th April. This is an opportunity to examine how a possible macroeconomic framework for a small economy might look in light of the lessons learned from the past six years. To ensure an informed discussion, a member of the Scottish Government’s Council of Economic Advisers will join three independent researchers involved in the economics of the Scottish referendum debate.
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- (Chair) Dr Angus Armstrong, National Institute for Economic and Social Research, Centre for Macroeconomics and ESRC Senior Scottish Fellow
- Professor Andrew Hughes-Hallett, George Mason University, St Andrews University and Scottish Government’s Council of Economic Advisers, Fiscal rules and financial regulation
- Gemma Tetlow, Programme Director, Institute for Fiscal Studies, Fiscal options and challenges for an independent Scotland
- Dr Monique Ebell, National Institute for Economic and Social Research and Centre for Macroeconomics, Scotland's currency options
- Professor David Bell, University of Stirling and ESRC Senior Scottish Fellow, Fiscal challenges under alternative constitutional arrangements
Dr Monique Ebell (NIESR) will present a summary of NIESR's published work on currency options and the financial framework. This includes findings published in a new Discussion Paper (No. 426) entitled “Assets and Liabilities and Scottish Independence” authored by Dr Angus Armstrong and Dr Monique Ebell and published on the NIESR website today here. The key findings are:
- The division of existing UK assets and liabilities would determine the initial economic conditions for an independent Scotland and therefore the appropriateness of its macroeconomic framework.
- The Whole Government Accounts (WGA) is the consolidated accounts of UK public sector assets and liabilities, including the Bank of England. The latest accounts for 2011-12 show a net liability (after taking into account assets) of £1,347bn. This compares to a public sector net debt (PSND) of £1,160bn.
- The best measure of market issued debt for the UK is gross debt (or ‘Maastricht’ definition debt). The OBR predicts this will be £1.7tn in 2015-16. If Scotland becomes independent, it is likely to benefit from receiving a geographic share of the North Sea oil and gas reserves and assume a population share of the gross debt of about £143bn. Its debt to GDP ratio would then be 86%.
- An independent Scotland would not have the resources to cover this obligation. Therefore, an IOU obligation would be created where the Scottish government would make annual payments to cover its share of debt interest plus the maturing debt. Approximately £23bn would be required in the first year plus whatever is required to cover the fiscal deficit.
- According to the OBR, the tax yield from oil and gas between 2019 and 2041 is estimated at £56bn. Assuming an independent Scotland receives 84%, the tax yield would be £47bn in cash terms (i.e. not discounted). This is about one-third of the value of debt an independent Scotland would inherit.
- Our report shows that because an IOU from independent Scotland would not constitute a liquid asset, the gross debt burden of the continuing UK would rise by 9 percentage points to 102%. This would be likely to catch the attention of credit rating agencies.
Tax revenues from offshore oil and gas are notoriously volatile. Revenues from oil and gas fell by almost one-half between 2011-12 and 2012-13 to £5.3bn, equivalent to 3% of Scotland’s GDP. The White Paper proposes building up an oil fund to be able to smooth out this volatility, but it is difficult to see how such an oil fund could be built up. In 2012-13, Scotland’s onshore fiscal deficit was 14.0% of its GDP.
- Armstrong and Ebell (2013) include an estimation of borrowing costs for nations in a formal monetary union. The most important determinant is the liquidity of national bond markets. Small countries in the Eurozone, such as Finland and the Netherlands, pay a premium on Germany’s borrowing costs, despite having a more favourable fiscal position. We conclude that an independent Scotland in a formal monetary union would pay between 0.72% and 1.65% more than the UK for issuing ten year bonds.
- The choice of currency is important, not only for trade and transactions costs, but also for the ability to resolve shocks and stabilize the economy. Scotland’s choice of currency must be appropriate for a small open economy with a high level of debt, volatile tax revenues and higher borrowing costs.
- Research (Armstrong and Ebell (2013) and (2014)) explains why a formal monetary union would not be in the interests of the UK or an independent Scotland. Combining the initial conditions with using the currency of another country would make Scotland a hostage to fortune. Possible higher exchange costs of 0.1% to 0.2% of GDP are much smaller than the cost of financial disruption. Economists at the IMF estimate the cost of crises in terms of lost output relative to trend is typically 20% to 30% of GDP
- The continuing UK would already have a £143bn IOU from an independent Scotland. It is hard to see why the government would increase this exposure by acting as lender of last resort to institutions in Scotland. A lack of sterling lender of last resort is likely to lead to financial institutions migrating south and higher borrowing costs as banks in Scotland compete with UK institutions for deposits.
Advocates of the currency union suggest these risks can all be managed by well designed cross-border fiscal agreements. History is less encouraging, not least because there can be no binding enforcement between sovereign states.