Does sterlingisation make sense for Scotland? Or would a separate currency be better?

Angus Armstrong writes:

Sterlingisation appears to offer continuity but in fact much would change. This is the riskiest of all currency arrangements being considered. With a debt burden of more than 80 per cent and projected fiscal deficits, Scotland would have little capacity for independent macroeconomic policy. It would have no capacity to provide emergency liquidity to its financial sector and little scope for a credible deposit insurance scheme (for instance, Panama does not offer deposit insurance).

Financial services are Scotland’s largest export sector. Scotland’s non-oil trade deficit has been around 7 per cent of GDP over the past three years. Therefore, the loss of financial services exports would leave the balance of payments very exposed to declining oil and gas revenues. The fall in general prices and wages to restore competitiveness could be substantial. As we have seen, governments with high debt levels, no control over their currency and external deficits can also need emergency support.

That is from an FT symposium on Scottish currency choices, which is interesting throughout, at least for those of us obsessed with the theory of optimum currency areas.

Euro adoption does not generate much sympathy as an option.  Opinions are mixed on an independent, floating currency.  In the steady state it could work fine, as is the case for Sweden.  I worry about the transition, however, and finding a proper conversion rate for current Scot bank deposits denominated in sterling.

If the expectation is that those deposits will be undervalued in the process of conversion, bank runs may ensue.  Another option is continuing uncertainty about future monetary policy for New Scot Lanarks, combined with prices which are slow to adjust to the new medium of account.  In fact pricing in terms of English pounds might remain the dominant practice for years.  In that case exactly what kind of monetary policy promise is the new Scot central bank making in the first place?  Everything is priced in terms of pounds, and the New Scot Lanark floats against the pound in a meaningless fashion.  Who should want to hold the New Scot Lanark in the first place?  Won’t any combination of announced conversion rates/monetary policy reaction functions involve some risk of a weak Scot currency and thus again ex ante bank runs?

Even Ronald MacDonald, who favors the independent currency option, wrote this in the symposium:

The currency is likely to be very volatile in any transition period and this would have implications for trade. However, the macroeconomic benefits of a separate currency clearly vastly outweigh the microeconomic costs, although the transition period is likely to be very painful.

I guess we’ll know soon enough how they vote.


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