The Scottish Government needs to move on from its political argument and form a currency strategy, writes Peter Jones
Today, The Scotsman hosts a conference on the extent to which the Scottish Government’s white paper on independence amounts to a business plan for Scotland. The foundation for such a plan rests on the currency and the Bank of England continuing as the central bank for both economies. The key question here is this: would the proposed sterling zone covering two sovereign governments be workable, stable, and advance the economic interests of both nations? So far, the Scottish Government has failed to produce the business plan to prove that would be so, though I don’t think it is impossible to do so.
The argument as it presently stands looks to be between two irreconcilable positions. The nationalist case says that because of shared trade, unhindered movement of labour and capital, broadly comparable levels of labour productivity, Britain as it stands looks to be as close to an optimal currency zone as you can get. This is perfectly true.
The unionist argument against this is that the problems of trying to fit monetary policy to two economies that might be diverging, of sorting out clear accountability for central bank operations to two governments and parliaments which may have very different ideas of what the bank should be doing, are impossible to resolve. I would argue they are difficult, but not impossible issues.
But as things stand, the resulting political clash – yes, a sterling zone can work and be in both countries’ interests; no, it can’t work and isn’t in both countries’ interests – isn’t very helpful. Any business where there was such conflict at boardroom level over a major strategic change of direction would be paralysed. But rather than continue with both sides hurling insults at each other, any board chairman would surely direct the quarrelling executives to see if they could work out a solution.
The problem here is that both sides are talking about different things which don’t overlap. The issue of benefits to trade and balance of payments on which the Scottish Government rests its case are different to the matters of monetary management and political accountability on which unionists rest their case.
No-one can expect unionists to come up with solutions to the problems they raise, so it is up to the Scottish Government to do that. In short, the Scottish Government needs to move on from its political argument and add a currency management business strategy.
The threats that ministers are making – that independent Scotland will refuse to take on any UK debt if it doesn’t get to share sterling and the Bank of England – are not credible and ill-serve its political purpose. To win the referendum, the SNP needs to convince Scotland that the transition to independence will be smooth and easy, but this threat promises only bad temper and conflict, not something likely to be attractive to undecided voters. A business plan it ain’t.
The possibility that there is a solution to the unionists’ problems is evidenced by the fact that between 1921 and 1999, Belgium and Luxembourg operated a currency union based on the Belgian franc inside a broader economic union. The fact that it survived 78 years, including five years of occupation when the franc was replaced by the Reichsmark, strongly suggests that such a currency zone is workable.
Details on how it operated are hard to come by (if any reader has more information I’d be glad to hear of it). But it does seem to fit the Scottish Government’s model: Belgium was much the bigger partner and had the central bank, which appears to have carried out Belgian franc banknote issuing and financial regulation for Luxembourg until 1983, when a Luxembourg monetary institute took over these functions. Luxembourg only created a central bank in 1999, when the Belgian franc was replaced by the euro.
So why won’t this work for Scotland and the rest of the UK? It is argued that the model entails a one-size-fits-all monetary policy. Indeed, the SNP seems to accept that there will not be different Scottish interest rates under independence, nor different policies for the quantity of money in the economy, or quantitative easing as this tool of monetary management is known.
The white paper says: “Where there is a fully integrated market with products about to be bought across Scotland and the rest of the UK, one common Bank of England interest rate for the sterling area [my emphasis] and close alignment between the two economies and regulatory structures, there is no reason for borrowing rates for consumers to be affected.”
A problem here is that monetary policy has become the key lever of economic management. An example at the micro-scale is the Bank of England’s funding for lending scheme which is designed to make it easier for commercial banks to lend money to house-buyers and small businesses. The Bank reckons there are now signs the housing market is over-heating, risking a property price bubble, and therefore the scheme has to be closed to home-buying. This may be true in London and the south-east, but it isn’t the case in Scotland. This monetary policy could be tweaked to deal with this issue. Supported lending could be allowed to continue in areas where there is no price bubble. Regions with allowable purchasable properties could be defined by their postcodes, thus preventing leakage of lending money from a non-bubble region to a bubble region.
Rather more difficult to manage is an external macro-shock which affected Scotland differently. Scotland would be an oil exporting country and the rest of the UK an oil importer. So a big oil price change, whether up or down, would affect both countries differently. One might need monetary expansion, the other monetary contraction.
At the moment, the Scottish Government, by accepting that interest rates and quantitative measures have to be set on a Britain-wide basis, has no answer to this problem. Yet it seems to me that one could be devised by using the proposed oil fund for occasional monetary management purposes.
There’s no space to go into how this might work, but the point stands. A business plan for these management issues, also for matters of governance and accountability functions, is not impossible. But until the Scottish Government produces that plan, the Yes campaign is going to be on the back foot on sterling.