SCOTTISH INDEPENDENCE: Attempts to create a formal currency union between an independent Scotland and the rest of the UK are likely to result in an arrangement similar to dollarisation, according to a new report.
The National Institute of Economic and Social Research (NIESR) has found that when there is a monetary union between two different-sized nations, there is no incentive for the larger country to impose fiscal constraints on the smaller country.
It also found that a banking union between two countries of differing sizes is unlikely to be sustainable.
The report follows months of debate about an independent Scotland’s currency options.
The Scottish Government has proposed a formal currency union in which Scotland would retain the pound and the Bank of England as the central bank. Monetary policy would be set according to economic conditions across the so-called sterling zone.
The UK Government has already rejected this plan, stating that such an arrangement would not be in the best interests of either country.
The NIESR research considers the prospects of a monetary union between two sovereign states of different size - such as Scotland and the rest of the UK - compared to traditional theoretical models which assume several countries of similar size.
It states that: “Scotland would have at most one representative on the Monetary Policy Committee, compared to the rest of the UK having eight”.
“It follows that the rest of the UK would dominate every decision and Scotland would have no effective influence on policy.
“Therefore, the Scottish Government’s fiscal or borrowing decisions could not directly influence monetary policy in the sterling area, which removes the rationale for borrowing constraints on an independent Scotland.”
Proposals for a banking union would also be unlikely to work in the long-term, the research found.
“In the event of a banking crisis south of the border, the size of a potential fiscal transfer from Scotland to the rest of the UK might be so large as to outweigh the benefits from remaining in the banking union. An independent Scotland would therefore have no incentive to participate,” the research states.
It concluded that even if a monetary union were agreed to in principle, without fiscal constraints or a banking union, this would resemble “de facto dollarisation”, in which a Scottish state could unilaterally adopt sterling without agreeing to a formal union.
A Scottish Government spokeswoman said: “All of the issues raised by the NIESR in this report have been dealt with in the detailed first report of the Fiscal Commission Working Group, published last year, which considered the post-independence currency options in detail and concluded that a currency union with the rest of the UK is the best option for both Scotland and the rest of the UK.
“Their recommendations include detailed proposals for a sustainability agreement, a stabilisation fund and for ensuring financial stability that will facilitate continued high levels of integration and ensure economic stability is maintained across the sterling area.
“In his speech in Edinburgh, the Governor of the Bank England set out the institutional arrangements required for a successful monetary union - these requirements were already addressed by the work of the Fiscal Commission and have not been accurately reflected in NIESR’s analysis.”