The Pound Poses a Problem for an Independent Scotland

Let me restate and possibly clarify points from a recent New York Times column on Scotland’s September 18 referendum on whether to leave the United Kingdom.

Declaring Scotland independent would mean a big disruption of existing economic and financial arrangements. As the Oxford economist Simon Wren-Lewis says, the preponderance of professional economic opinion is that this disruption would leave Scotland worse off, but that is a point we can argue. However, that is not the argument the independence movement is making.

What they have been telling voters is that there would be no disruption — in particular, that Scots could continue using the British pound, and that this would pose no problem.

This is an astonishing claim to make at this point in history. Economists (starting with my late colleague and friend Peter Kenen) have long argued that sharing a currency without fiscal integration is problematic; the creation of the euro put that theory to the test. And the results have been far worse than even the harshest critics of the euro imagined, with euro Europe doing worse at this point than Western Europe did in the 1930s.

And an independent Scotland using the British pound would arguably be in even worse shape. Europe has somewhat stabilized recently thanks to European Central Bank President Mario Draghi’s support for debtor countries. But Mr. Draghi is able to do this, in large part, because he is answerable to the whole euro area, not just to Germany. An independent Scotland would be dependent on the kindness of the Bank of England with no say whatsoever in its policies.

I’ve read quite a lot of the independence literature, and it shows no appreciation for the dangers involved. What Scottish voters should do is look hard at the experience, just across the North Sea, of divorcing currency from statehood. It’s not encouraging.

Day of IMFamy

Two pieces I wrote for the International Monetary Fund are online. First, the text from my Mundell-Fleming lecture, on the possibility, or lack thereof, of Greek-style crises in countries that borrow in their own currencies. Second, a set of brief notes from various recipients of the Nobel.

My conclusion from the Mundell-Fleming lecture: “[C]laims about the vulnerability of floating-rate debtors to crisis haven’t been given any specificity because they do not, in fact, make sense. Simple macroeconomic models suggest that a loss of confidence in a country like the United States, taking place at a time when interest rates are at the zero lower bound, should, if anything, have an expansionary effect. Nor can one appeal to the lessons of history: Cases resembling the hypothesized crisis scenario are rare, and those that exist don’t support the notion that Greek-style crises can take place under a very different currency regime.

“You may find it implausible that conventional wisdom, backed by so many influential people, could be wrong on so basic a point. But it’s not the first time that has happened, and it surely won’t be the last.”