Currency and Fiscal Policy Options for an independent Scotland

Lead Research Organisation: National Institute of Economic and Social Research
Department Name: National Institute of Economic & Soc Res

Abstract

SUMMARY
The objective of this Fellowship is to stimulate an open and informed debate on the coherence of alternative currency and fiscal arrangements for Scotland. This issue is at the heart of whether full or further devolution will be successful. Since independence is likely to be irreversible, at least for several years, an informed debate requires understanding all of the currency and fiscal options across a spectrum of sovereignty rights, whether or not they are part of a referendum.
Scotland's future currency and fiscal arrangement is at the heart of whether full or further devolution will be successful. The Parliament of Great Britain with full currency, fiscal and political union began with the Acts of Union in 1707 and has endured longer that all other monetary unions between nations. Monetary unions which have logical inconsistencies have always been eventually exposed by an unforeseeable economic shock. History is replete with instances in which failed unions lead not only to economic crises but often political division. The academic community has a responsibility to propose currency and fiscal arrangements which have integrity and be unapologetic in highlighting those which are inconsistent.
The current economic crisis shows how failure to understand risks and misaligned incentives in the financial system can undermine policy frameworks. The number of financial crises around the world over the last three decades, and in particular the recent global crisis, shows how private sector risks can become public sector liabilities as the state remains the ultimate insurer of systemic risk. With the large transfer of financial sector exposures to the public sector the previous working assumption of a division between currency (or monetary) policy and fiscal policy has become exposed as an over-simplification.
The traditional approach of an optimal currency area developed in the 1960s must be extended to include financial sector risks. Only when financial sector risks are fully incorporated can the integrity of the new currency and fiscal arrangements be judged. This Fellowship aims to make this extension. The liabilities of the banking system are assumed to be contingent fiscal risks of the state. This brings financial supervision and non-monetary policies (i.e. bank support policies) by the central bank into the centre of the debate. This creates a clear link between monetary and fiscal policies. These risks are central to Scotland - a small and open economy with a large financial sector. Failure to consider currency, fiscal and financial arrangements together would be a serious omission in this debate.
This Fellowship will examine Scotland's currency and fiscal policy options from a joint macro-economic and macro-financial perspective. The macro-economic perspective looks at the structure of an independent Scottish economy (more oil-based and without the Barnett fiscal transfer) and fiscal sustainability. The core of the Fellowship is building the first large-scale global econometric model of Scotland. This will be an extension of NIESR's National Institute Global Economic Model (NiGEM) which has over 40 model subscribers, mainly in the policy community, including the Bank of England, the FSA, the ECB, the OECD, the IMF. The macro-financial perspective will focus on the Scottish banking system as a state contingent liability. The key issues are what are the choices of institutional arrangements for providing financial sector support (such as lender of last resort and deposit insurance) and who will be the regulator. While it is possible to contract-out these operations, this will involve a fiscal cost and raise moral hazard issues.

Planned Impact

IMPACT SUMMARY
Who and How
In the public sector the Office of Budget Responsibility and Scottish Government will benefit by having a fully integrated global econometric model with Scotland included. Both institutions have approached the NIESR with regard to developing this model. This will help them in their economic and fiscal forecasts which are the foundation of setting the annual government budgets.
The Bank of England will also benefit from the same global econometric model of Scotland. Whatever the outcome of the referendum it will be beneficial to have a detailed model of a significant part of the UK economy. The Bank is already a user of our model. The Bank is also expected to benefit from having an independent valuation of the cost of central bank support measures. These costs ought to be paid by the beneficiary - the banking sector.
Businesses in Scotland, particularly the financial sector, will benefit from an open and non-partisan discussion on the future of financial regulation and the institutional framework for supporting the financial system.
If the Institute for Fiscal Studies have a "Green Book" for Scotland then the overall macroeconomic setting of any future budget will need a macro-economic model. We would be pleased to support the IFS using the NiGEM with Scotland model.
The IMF and OECD consult with NIESR when carrying out their annual Article 4 economic assessments. It is highly likely that both institutions will take a close interest in the independence debate and the potential economic consequences as the referendum draws closer. As we have close relationships with both organisations, we would certainly be asked to share our work and the version of NiGEM with Scotland (they are both subscribers).
The currency and fiscal choices facing Scotland are certain to be at the centre of the public debate in the lead up to the referendum. We hope that the arguments and evidence we are able to provide through this Fellowship will lead to a far higher understanding of the issues on both sides of the debate.
The public is NIESR's most important stakeholder. We hope that through our Pathways to Impact we have shown how we intend to engage with the public, across all sections, and that they can therefore benefit from our findings helping them to make an informed decision in this momentous referendum.

Publications

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Armstrong A. And Ebell M. (2014) The Economics of Scottish Independence: Introduction in National Institute Economic Review

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Armstrong A. And Ebell M. (2014) Scotland: Currency Options and Public Debt in National Institute Economic Review

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Armstrong, A. (2014) Scotland's Lender of Last Resort Options in NIESR Publications

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Armstrong, A. (2014) Assets and liabilities and Scottish independence in OXREP - Oxford Review of Economic Policy

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Armstrong, A. And Ebell, M. (2014) Scotland's Decision - eBook

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Armstrong, A. And Ebell, M. (2014) Commentary: Monetary Unions and Fiscal Constraints in National Institute Economic Review

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Armstrong, A. And Ebell, M. (2014) Is this Plan B?

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Armstrong, A. And Ebell, M. (2013) Scotland's Currency Options in NIESR Publications

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Armstrong, A. And Ebell, M. (2014) Real Devolution: The Power to Borrow in NIESR Publications

 
Title Scottish Independence: The Big Money Question 
Description The animation is based on research from NIESR which is supported by an ESRC Senior Scottish Fellowship and it describes the main currency choices which would face an independent Scotland, with an impartial look. The animation is written and produced by ECON FILMS (@econfilm) with thanks to Aurora Digital Post and Lee Robson Spence 
Type Of Art Film/Video/Animation 
Year Produced 2013 
Impact The video hit nearly 140.000 views, a huge success and one of the most ever viewed economic research's videos on YouTube. It also helped to create further debate on the topic, as showed by more than 2.200 comments below it. 
URL http://www.youtube.com/watch?v=mBC0mLFz91o
 
Description In our research we explained the currency options, likely division of assets and liabilities, possible borrowing costs and financial sector consequences of Scottish independence. These issues were at the centre of the independence debate.

Are findings indicated that an independent Scotland would be unlikely to form a fromal currency union with the rest of the UK due to the amount of debt it would assume if it became an independent nation. In the event of an independent Scotland entering into an adverse economic situation, its high debt level (assuming it accepted a per capita or GDP share of existing UK debt) would limit room for fiscal mobility and its lack of effective representation at a central bank would rule out monetary policy. The consequences could be that borrowing costs rise further possibly destabilising the economy.

We carried out a detailed econometric study to estimate the borrowing csots for an independent Scotland. We estimated that these would be between 0.68% and 1.62% higher than for the rest of the UK and its banking sector would be largely based on bank subsidiaries from the rest of the UK.

We showed how a banking union between tow such different sized nations would be difficult to achieve. This is because the large country could always bail out the samll country but the small country could not bail out the large country. Scotland is 8.5% of the UK. Therefore, this begs the question of why the rest of the UK would enter this agreement.
Exploitation Route 1. Monetary and banking unions with asymmetric sized countries
2. Issues in providing cross-border lender of last resort arrangements in Europe
3. Approaches to sub-central government borrowing costs in the UK
4. The limits to risk sharing in banking unions (EU)
Sectors Education

Financial Services

and Management Consultancy

Government

Democracy and Justice

URL http://niesr.ac.uk/research-theme/economics-scotland
 
Description Our research findings were frequently cited in reports by the UK and Scottish Governments, in debates in both parliaments. The issue of currency was central to the debate and we were recognised as the main independent authority on this issue. Our work was cited many times by Danny Alexander, Alistair Darling and senior Scottish Government officials commenting on the importance of our work. We were frequently on leading TV and radio discussing the issues such as the Today Programme, BBC News 24, Sky News nd Newsnight. Our work was regularly cited by the UK and international media. According to our media count service, our research was cited in the media over 1000 times in the year before the referendum (an average of around 3 times per day). We provided evidence as expert witnesses to select committees in both the Scottish and Westminster Parliaments on many occasions including the Treasury Select Committee, Scottish Affairs Committee, the Finance Committee, Economic Energy and Tourism committees and as Special Adviser to the House of Lords Economic Affairs Committee. We took part in many public debates including at the British Academy, Royal Edinburgh Society, Royal Economic Society, Scottish Econoic Society, Glasgow, Stirling and Edinburgh Universities as well as for many privately supported events. Our research was published in chapters in three books, three refereed journal articles, discussion papers and speeches and blogs. We also experimented with innovative media such as an annimation for YouTube which has been watched by 186,000 viewers. Our findings were cited in almost every major investment banks' research and by all of the credit rating agencies. In the EU referendum some of the issues raised were again referred to. This is particularly the case for financial services. In 2021 with the possibility of a second Scottish Referendum looming, we have been asked to engage one again in these issues. An important research report published by the ESRC Centre CEP references our papers from this project as key research in this area. We aim to add a discussion paper adding a further dimension through our ESRC Rebuilding Macroeconomics grant.
First Year Of Impact 2013
Sector Education,Financial Services, and Management Consultancy,Government, Democracy and Justice
Impact Types Societal

Economic

 
Description Borrowign costs
Geographic Reach National 
Policy Influence Type Citation in other policy documents
Impact Our estimates of Scotland's borrowing costs were cited by governments, major banks and credit rating agencies
 
Description Scotland Currency Options and Borrowing Costs
Geographic Reach National 
Policy Influence Type Citation in other policy documents
Impact NIESR research was regularly cited by the UK Government, Scottish Government, both debate campaigns, financial institutions, in high profile policy announcements in the UK and Scottish Parliaments.
 
Title Borrowing costs 
Description We created a statat model to estimate Scotland's potential borrowing costs using a panel of EMU nations 
Type Of Material Data analysis technique 
Year Produced 2014 
Provided To Others? Yes  
Impact Both UK and Scottish Governments requested and received the model and data 
 
Title NiGEM-S 
Description A model economy for Scotland in a Global Econometric Model. 
Type Of Material Computer model/algorithm 
Year Produced 2014 
Provided To Others? Yes  
Impact Held a seminar for academcis in Scotland and model is used for simulations by Scottish Parliament Information Centre 
 
Title NiGEM-S Model: Scottish version of the National Institute Global Econometric Model 
Description The NiGEM-S model creates a model economy of Scotland integrated into a global economic model. This is based on the National Institute Global Econometric Model, NiGEM, a large-scale structural macro-econometric model of the world economy which has been developing since 1987. The model is freely available to all Scottish Higher Education institutions and can be downloaded from the website. 
Type Of Technology Software 
Year Produced 2014 
Impact NiGEM-S has two additional countries/regions and one extra-regio sector - Scotland, the rest of the UK and North Sea oil and gas sector - which are used in conjunction with the current UK model. The simulation options are limited to those affecting Scotland, the rest of the UK or North Sea oil and gas sector. This allows modelling of different fiscal assumptions for Scotland and the rest of the UK. 
URL http://nimodel.niesr.ac.uk/
 
Description Chaired Special Session at Royal Economic Society Annual Conference 
Form Of Engagement Activity Participation in an activity, workshop or similar
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Professional Practitioners
Results and Impact We invited speakers from both sides of debate (a rare occassion)

Better understanding of issues
Year(s) Of Engagement Activity 2014
 
Description Conference at the Institut d'Estudis Autonomics, Barcelona 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Other academic audiences (collaborators, peers etc.)
Results and Impact The talk sparked an interesting discussion with Catalan academics and policymakers on the comparative economic implications of Scottish and Catalan independence, in particular fiscal and monetary aspects.

The talk had local press coverage.
Year(s) Of Engagement Activity 2013
 
Description Debate on Scotland's future 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Public/other audiences
Results and Impact The talk contributed actively to the discussion.

It has been asked for further involvement
Year(s) Of Engagement Activity 2014
 
Description Evidcence to Treasury Select Committee 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact Evidence on devolving fiscal powers to Scotland

Informed policy makers.
Year(s) Of Engagement Activity 2014
 
Description Evidence to Scottish Parliament 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact Should Scotland have a Fiscal Responsibility body

Informed important decision
Year(s) Of Engagement Activity 2014
 
Description Evidence to Scottish Parliament 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact Scottish independence, debt obligations and borrowing costs

Informed policy
Year(s) Of Engagement Activity 2014
 
Description Evidence to Scottish Parliament's Economy, Energy and Tourism Committee 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact The MSPs on the committee asked questions of the panel members on their views on the best currency arrangement for an independent Scotland.

Played an influential role in informing the opinions of MSPs on the optimal currency arrangement for an independent Scotland.
Year(s) Of Engagement Activity 2014
 
Description Festival of Politics: Panel on Scotland's currency options 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Public/other audiences
Results and Impact Talked sparked questions and an engaging debate.

It has been asked for possible future collaborations.
Year(s) Of Engagement Activity 2014
 
Description Finance after a 'YES' Conference 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Other academic audiences (collaborators, peers etc.)
Results and Impact It has been an highly valued contribution by the audience.

Further discussions arose.
Year(s) Of Engagement Activity 2014
 
Description HM Government's Scottish Afairs Committee 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact Evidence on Scotland's currency options in event of independence

Informed policy and widespread media coverage in Scotland
Year(s) Of Engagement Activity 2014
 
Description HM Government's Scottish Afairs Committee 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact Public round table in Scotland on currency options

Informed policy and significant media coverage
Year(s) Of Engagement Activity 2014
 
Description HMT Scotland Roundtable in Glasgow 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact During the roundtable, a lively discussion on the relative economic merits of small and large economies, and the relationship of country size to decentralization was sparked, which aroused great interest among policymakers.

The roundtable discussion will have informed HM Treasury officials' views on the potential implications for the UK and Scotland of Scottish independence, as well as on devolution and decentralization across the UK.
Year(s) Of Engagement Activity 2013
 
Description National Institute of Economic Review on The Economics of Scottish Independence Press Conference 
Form Of Engagement Activity A press release, press conference or response to a media enquiry/interview
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Media (as a channel to the public)
Results and Impact It has been a really participated press conference with lots of questions form journalists.

After the Press Conference in London, we held another one in Edinburgh, both with huge press coverage by national media (major newspapers, TVs and BBC News interview)
Year(s) Of Engagement Activity 2014
 
Description Public sector debt, borrowing, taxation and fiscal rules - Evidence presented to Scottish Parliament's Finance Committee 
Form Of Engagement Activity Scientific meeting (conference/symposium etc.)
Part Of Official Scheme? No
Type Of Presentation paper presentation
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact This paper briefly summarises some findings and ongoing research on the economics of Scottish independence funded by the Economic and Social Research Council, ...........................

The Scottish Parliament's Finance Committee ..............................
Year(s) Of Engagement Activity 2014
URL http://niesr.ac.uk/sites/default/files/publications/SP_fiscal_NIESR.pdf
 
Description Special Session at the Royal Economic Society Conference 
Form Of Engagement Activity Scientific meeting (conference/symposium etc.)
Part Of Official Scheme? No
Type Of Presentation paper presentation
Geographic Reach National
Primary Audience Other academic audiences (collaborators, peers etc.)
Results and Impact The special session (organized by NIESR) provided an opportunity for economists with diverse views on the economic implications of Scottish independence to present their work.

Awareness of issues relating to the economic implications of Scottish independence was raised among leading UK academics and policymakers.
Year(s) Of Engagement Activity 2014
 
Description Speech at Conference on Scottish Independence at Queen's University, Belfast 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Public/other audiences
Results and Impact The talk has been followed by an interesting debate on the implications of independence for Scotland's borrowing costs, as well as possible economic impact of Scottish independence on Northern Ireland and other regions.

Ahead of the talk a Radio Interview has been requested and recorded.
Year(s) Of Engagement Activity 2014
 
Description Speech at IPPR North Event 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach Regional
Primary Audience Public/other audiences
Results and Impact My speech was focused on the consequences in case of a yes vote at the Scottish Referendum on Independence

The talk has been ...
Year(s) Of Engagement Activity 2014
 
Description Speech at Royal Edinburgh Society 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Public/other audiences
Results and Impact Informed debate and widespread media coverage

Monetary union between asymmetric sized nations became widely discussed
Year(s) Of Engagement Activity 2014
 
Description Speech at Scottish Economic Society 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Professional Practitioners
Results and Impact Improved understsanding of banking union

Secottish Economic Society published an e-book of conference
Year(s) Of Engagement Activity 2014
 
Description Speech at Scottish Parliament 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact The talk was about ...

After this, it has ...
Year(s) Of Engagement Activity 2014
 
Description Speech at the Centre for Macroeconomics Workshop 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach Regional
Primary Audience Other academic audiences (collaborators, peers etc.)
Results and Impact The talk led to an interesting discussion among leading UK academics on the desirability and feasibility of fiscal rules and a banking union for an independent Scotland.

Awareness of issues related to fiscal rules and banking unions in an asymmetrically sized monetary union without political union was raised among leading UK academics.
Year(s) Of Engagement Activity 2014
 
Description Speech at the Scottish Parliament Information Centre (SPICe) 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach Regional
Primary Audience Policymakers/politicians
Results and Impact The presentation gave SPICe researchers an in-depth overview of the main issues around currency options for an independent Scotland. SPICe staff support MSPs.

There was a high level of involvement of SPICe staff in the talk, as evidenced by a large number of questions. The talk will have informed SPICe staff about the potential economic implications of Scottish independence.
Year(s) Of Engagement Activity 2014
 
Description Speech on Scotland Independence to Chevening Scholars 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Postgraduate students
Results and Impact After the speech a lively discussion on the possible economic impacts of Scottish independence.

After the talk many talented postgraduate students from around the world who are recipients of Chevening scholarships asked for more information.
Year(s) Of Engagement Activity 2014
 
Description sc 
Form Of Engagement Activity A formal working group, expert panel or dialogue
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Policymakers/politicians
Results and Impact Scotland's currency options in event of independence

Informed policy and widely covered in media
Year(s) Of Engagement Activity 2014