If, as the adage goes, history rarely repeats itself but often rhymes, then Scottish voters may be dangerously close to the end of a verse.
On Thursday, Scottish voters will go to the polls to vote on whether or not to leave the United Kingdom. Unfortunately, the plan for independence does not include monetary independence.
At first glance, this policy may seem somewhat sensible. Breaking up is hard to do. Scotland has a lot of trade with England, and introducing a separate Scottish currency would complicate that relationship as the exchange rate between the Scottish currency and the British pound fluctuated. Keeping a single currency would allow Scotland to avoid erecting barriers to trade that could harm its businesses.
Yet, monetary union would also have a number of other consequences that would threaten a politically independent Scotland’s economic well-being. As recent European history demonstrates, states cannot live by monetary union alone.
A monetary union is essentially an agreement among member states to use the same currency. This provision can have economic benefits, such as supporting economic integration among member states and promoting a freer flow of people and resources across borders.
However, monetary unions can be unstable if unaccompanied by deeper political, fiscal, and banking ties. When states in a monetary union remain politically independent, they set fiscal policy (taxing and spending decisions) and banking policy (banking regulations and safeguards) at the state level – not the union level. At the same time, they give up their monetary independence (the ability to control their currency) to the union.
These characteristics make each individual state, rather than the broader union, responsible for its individual economic performance, while simultaneously handicapping its ability to influence that performance.
The economic integration that characterizes a monetary union allows people and resources to flow more freely across borders, but it also makes the flow of things like economic crises and banking panics easier, as well. Problems spill over across borders, leading to union-wide crises. But because each state is politically independent, these union-wide crises are met with state-level responses which are wholly inadequate because each state has systematically given up its most potent policy tools in order to be a member of the monetary union.
For instance, independent states use their central banks to counteract economic crises in a number of ways. They lower interest rates to encourage consumption and boost economic activity. They also act as a ‘lender of last resort,’ preventing the state’s banking system from collapsing by making sure that banks have access to credit when normal credit channels seize up.
Furthermore, monetary policy is set union-wide, even though different states may have very different economies and very different economic needs. This virtually ensures that inappropriate monetary policies will be applied to at least some states in the monetary union, as there is no single optimal monetary policy for all member states.
These issues are not just academic. Scotland need only look as far as the Eurozone for a clear example of these problems. High interest rates on government bonds and a weak banking system have stymied economic recovery, while the European Central Bank (ECB) has struggled to balance the needs of its many different member states. Crises in one state quickly spill over into others. Ceding monetary authority to the ECB has severely hampered individual states’ recovery efforts, leading to persistently high unemployment and persistently low economic growth.
Actually, Scotland’s case has the potential to be even worse than that of the Eurozone. If Scotland is allowed to stay on the pound after political independence, they would not only be ceding monetary authority, but they would be ceding monetary authority to another state. At least the Eurozone has a nominally European institution to set its monetary policy. Scotland would be dependent on the Bank of England, which would set policy based on England’s economic needs, regardless of Scotland’s situation.
Independence is a very romantic notion, but Scotland should not pursue it at the expense of its own economic health. If Scottish voters wish to break away from the United Kingdom, then they should assert their monetary independence, as well. If they fail to do so, they court the most predictable of disasters.