On 17th October, Nicola Sturgeon presented the SNP’s economic proposals for an independent Scotland, including on the currency. Albeit with slightly less fanfare, on the same day I published a report, Twenty-First Century Central Banking and an Independent Scotland’s Currency Choice. The report argues that the increased importance of central banks to government financing, as shown particularly during the pandemic and the aftermath of the recent Kwarteng ‘mini-budget’, has materially changed the choice between an informal currency union with the remaining UK (rUK) and a new Scottish currency, in favour of the latter.
On the surface, the government’s proposals on currency appear little changed from the Scottish Growth Commission (SGC) in 2018. An independent Scotland would continue to use Sterling in an informal currency union with rUK until such time as a set of tests are passed that justify the introduction of a Scottish pound.
However, this masks significant changes in the new proposals. The first regards timing. The SGC suggested use of Sterling continue for a ‘possibly extended transition period’ of uncertain length. In contrast, a new currency would now be introduced ‘as soon as practicable’. Sturgeon would not to be drawn on precise timing, but she pushed back on a questioner talking of ‘a decade or more’. If the message on a new currency in 2018 was more ‘if, not when’, now it is definitely ‘when, not if’. The second change is that informal currency union is now clearly seen as suboptimal, and something to be exited as soon as possible. This is really the only reasonable position for the Yes campaign to take, given the not unjustified claim that the impact of the mini-budget on Scotland’s mortgages and overall economy boosts the case for independence. As I argued in my report, informal currency union offers little protection for Scotland from the consequences of Westminster’s macroeconomic decisions.
The proposals do not offer a convincing case for a transition period using Sterling after independence rather than launching the new currency on day 1 of independence. The proposals set outs requirements and criteria for the adoption of a new currency, but a newly-independent Scotland would need to meet nearly all these requirements and criteria immediately for independence to be a success.
The Scottish Government’s report identifies three requirements.
1. that the institutional structure – the key fiscal, financial and monetary institutions – is in place
and can be extended to take on additional functions to support the introduction of a Scottish
This is essentially two requirements, the establishment of the institutional structure and the challenge of additional responsibilities. The proposal rightly sets out details on the institutions Scotland would need, or need to enhance, on independence, including a central bank, debt management office and the Scottish Fiscal Commission. The most important institution would be the Scottish central bank. The economic proposal envisages sensibly that the central bank would have ‘oversight of monetary and economic conditions in Scotland and…responsibility for financial stability. The Scottish Central Bank would also report on the economic criteria and conditions for moving to a Scottish pound.’ The expertise needed to fulfil this function from independence would have to be sufficient to meet the subsequent challenges of monetary policy and financial stability in a new currency. The change would be from knowing the right policies, but lacking the mandate or capacity to carry them out fully whilst in an informal currency union, to knowing the right policies and having that mandate and capacity to implement them.
This is not to minimise the challenges of establishing the capabilities for managing a new currency, but the challenges have been met before by countries in far less auspicious circumstances and without the (likely extended) period of negotiation between any vote for independence and independence itself.
2. that there is market confidence and credibility in the macroeconomic framework to support
The intention is to transition to a new currency as soon as practicable. Unless the market is confident from the day of independence that the macroeconomic framework to support that transition is credible, investment in and lending to Scotland would be curtailed by domestic and international investors. In the market for Scottish government bonds, investors may well be happy to lend for short maturities, confident that they would be repaid before transition, or they may demand an option to be repaid in the event of the transition. This is similar to the City of Aberdeen bond launched in 2016, which contained an option for investors to be repaid in the event of independence. Longer term investment in Scotland would be negatively impacted.
It is difficult to see how this ‘macroeconomic framework to support a transition’ would vary meaningfully from the macroeconomic framework to support independence. The bulk of the framework would have to be the same. Where they vary, for example in having an inflation target for the Scottish central bank, there seems little doubt as to what that target would be, and investors would want to be reassured on that point from day 1 of independence. In one area, sustainability, the proposals already signal future intentions regarding the mandate.
3. that change is in the economic interests of Scotland, and meets the macroeconomic objectives
of improved competitiveness and enhanced economic resilience
This appears to be ‘we reserve the right to change our minds’, at least temporarily. The change is presumably already seen as improving competitiveness and economic resilience in any longer-term analysis. As my report makes clear, I agree. The possible need to establish a new currency before EU entry only increases the need for transition. A future Scottish Parliament could reject the case for a new currency under the proposals, but this is slightly increased uncertainty for little if any apparent gain.
The report also outlines three criteria that would have to be met before a decision to transition to a Scottish currency.
1. that the Scottish Central Bank has established its credibility. The phase of continued use
of sterling would allow time for new institutions to be created and for these institutions to
establish a track record
It is clearly the case that delaying the introduction of a new currency allows more time, and that a Scottish central bank has no track record. I have argued above that there should be sufficient time before independence and that the bulk of the work on institutional capacity would have to be completed by that time for independence to be a success. A track record is helpful to the credibility all institutions and governments, and but its importance should not be over-stated in this case. The proposals list five ways fiscal credibility might be established, only one of which involves a track record, and the situation is similar in the case of monetary policy and financial stability. A record in a very limited role in these areas is being seen as establishing credibility in the greater role overseeing the Scottish pound. This credibility will be based on factors such as the identity and prior track record of the individuals appointed, especially of the new Governor. Market perception of a new Governor’s credibility as sufficient in the context of using Sterling and then transitioning to a new currency would differ little from the credibility to manage a Scottish pound. The commitment to transition to a new currency as quickly as possible means the credibility to manage the new currency will be vital from day 1 of independence. An institutional track record is only a small additional benefit.
2. that foreign exchange reserves and sterling reserves are sufficient
The proposals credibly claim that Scotland should inherit something like $14 billion of foreign exchange reserves from the Bank of England, and the suggestion is that these would be converted to Sterling for use meeting financial stability responsibilities, potentially topped up by borrowing. Sterling reserves would be relevant only during the time that Scotland is using Sterling; once the new currency is launched, Sterling reserves are foreign currency reserves. Lender and Buyer of Last Resort functions could then be fulfilled by the central bank creating the new currency. Sterling reserves, and whether they would be sufficient for financial stability activities, is therefore a question that would only need to be addressed at independence. Foreign exchanges reserves are unlikely to be a meaningful constraint on establishing the new currency unless the Scottish central bank intended to intervene to support the Scottish pound’s value. If the new currency is allowed to float with market demand, then relatively low levels of reserves would suffice. If the policy choice is to fix its currency to another such as Sterling, much higher levels of reserves are needed, as the UK found to its cost in 1992. Without a strongly positive current account balance, building that level of reserves in any reasonable timescale is unlikely.
3. that Scotland is fiscally sustainable
If independence is to be successful, Scotland must be perceived as fiscally sustainable at independence. Fiscal plans from day 1 of independence would have to include plans for a transition to the new currency. Without fiscal sustainability, the Scottish government would struggle to borrow, whether to finance the fiscal deficit or build up reserves. As the proposals note, such borrowing is a normal part of government activity. It’s also essential for any government. The proposal talks effectively about how Scotland might establish a framework for fiscal sustainability. A track record in applying such a framework would help, but only at the margin. As recent events show, credibility in this area must be maintained on an ongoing basis, and can be lost quickly, whatever the track record. The most important point, however, is that Scotland would need that fiscal credibility at the outset of independence.
Overall, these requirements and scenarios do not represent meaningful constraints on a new currency, largely because they would have to be met for independence to be a success, even in the context of continued use of Sterling. By setting out a policy of a new currency as soon as practicable, the new economic proposals implicitly and rightly acknowledge that informal currency union with the remaining UK is not an attractive position for Scotland. The proposals for a future transition with tests that, even if based on ‘transparent criteria and economic conditions’, must be somewhat subjective adds an avoidable additional uncertainty.
As I outlined in my report, a new currency is an independent Scotland’s best option, and informal currency union its worst. The Scottish Government’s economic proposals for independence appear to be a move in that direction relative to the SGC in 2018. However, they do not present a convincing case for a period of continuing to use Sterling rather than moving immediately to a new currency. None of the ‘successful independent countries’ the proposals consider choose informal currency union. The proposal is ‘grounded in practicality for households and businesses’, but an indeterminate but short time with continued dependence on decisions in London and reduced protection from the consequences of those decisions is neither practical nor necessary. The immediate adoption of a new currency will still involve an extended period of transition as Scottish households and businesses increasingly use the new currency, but it is best that this transition starts with independence.
Dr Iain Hardie is a Senior Lecturer in International Relations at the University of Edinburgh’s School of Social and Political Science. He is an expert on political economy, with a particular focus on financial globalisation, financial markets and government bond markets.