What are the knowns and unknowns of an independent Scottish currency?

Knowing the limits of their knowledge, they can make plans. The uncertainty which comes with unknown unknowns means they need to be ready to respond to whatever happens, adapting plans as they receive more information.

One way of assessing the Scottish Government’s paper A Stronger Economy With Independence would be to say that it makes a considerable effort to avoid definite commitments so that there is no risk of being hemmed into a position that it might subsequently regret. It sets out a variety of possibilities, knowing that “unknown unknowns” will be important in determining the choices it needs to make.

This could be one explanation for the Scottish Government’s hesitancy about recommending the rapid launch of a new Scottish currency. It simply wants to leave some room for manoeuvre in future.

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Business for Scotland had a very careful, measured response, recognising this proposal differs substantially from previous versions by emphasising that the end point of transition will be a Scottish currency but arguing it should be possible to accelerate that timetable.

We might ask whether this is the Scottish Government’s intention. It is proposing that the Scottish central bank will offer guidance about the timing of the currency launch. It downgrades tests to determine that timing, turning them into criteria which should guide Parliament.

That is very different from the Treasury under Gordon Brown, which delivered five thick volumes of analysis to bury proposals for UK membership of the euro. The central bank will be interested in whether establishing a Scottish currency will increase monetary and financial system stability.

Assuming it is filled with doughty technocrats capable of seeing off politicians in turf wars, the Scottish central bank and the finance ministry will negotiate with partner institutions in other countries.

With preparations starting as soon as the referendum is over, these discussions should permit the central bank to provide the necessary certification for the launch of the Scottish currency shortly after independence day. It then becomes a political decision whether the time is right to launch a Scottish currency, and the Scottish Government is clear that it will do this quickly.

It is on that basis that we should read the excellent paper produced by Iain Hardie for Edinburgh University’s Centre on Constitutional Change last week. Dr Hardie starts from the premise that currency arrangements are political responses to the economic environment.

Reviewing the role of the Bank of England in the last 15 years, he notes it has become an important supplier of liquidity to the financial system. In the financial crisis, central banks made money available to commercial banks, purchasing assets, typically government bonds from them.

In the “dash for cash” at the beginning of the pandemic, we saw a similar process. Dr Hardie describes central banks as becoming the “buyer of last resort” for government securities. He points out that the Bank of England’s purchases of government debt over the last two years are almost the same size as the public-sector deficit.

THE sad tale of Trussonomics is an additional British twist in this tale, with the Bank of England once again intervening to stabilise financial markets and effectively funding the Government deficit.

For the last 25 years in Japan and for 15 years globally, central banks have been using their unlimited ability to create the money needed to stop financial markets from seizing up. This approach is still often described as unconventional monetary policy”. And so, Dr Hardie asks the question of how long it takes for arrangements that were once unconventional, or novel, to become accepted and routine. This leads him to conclude that the arguments against Scotland using sterling in an informal currency union are now much stronger than before. Financial systems now rely heavily on central banks to provide enough liquidity for them to work well.

The conclusion that Scotland needs its own currency presumes there cannot be an agreement about some sort of “sterling zone”’ A century ago, as colonies began to become independent, there was a widespread presumption that British economic power would continue to be projected through common currency arrangements. If we can have unconventional monetary policy, we can also have unconventional monetary institutions.

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All those questions which I posed last week can be swept aside if there is sufficient political will. There is even a good argument that once the referendum has been decided in favour of independence, the Bank of England will be very helpful in enabling the establishment of cross-Border co-operation.

The flaw in this argument is that the Bank of England will only become involved after the referendum. Up until that point, the UK Government will have every reason to pour cold water on such proposals, as it backs the continuation of the Union.

In a purely economic environment, threats to withhold co-operation might be safely dismissed. In a political environment where persuasion and reassurance are necessary, they can be very effective.

Those threats are “known knowns”. They can easily be avoided by careful planning. That seems likely to mean co-operation on currency when it is in Scotland’s interest but being ready to launch a separate currency very quickly if that turns out to be necessary.