Scotland will probably have to mirror the euro region’s integration plans and surrender some sovereignty if the nation votes to leave the U.K. and keep the pound, Bank of England Governor Mark Carney said.
Scottish First Minister Alex Salmond wants to retain the currency and the central bank should he prevail and secure independence following a Sept. 18 referendum. Carney said policy makers need to “consider carefully” the financial stability risks associated with such a monetary union. Speaking after a meeting today with Salmond in Edinburgh, he said nations in the euro region were moving toward more integration.
“The degree of fiscal risk sharing will likely have to be significant,” Carney told business leaders in his first considered remarks on Scottish independence since taking his post in July. “A durable, successful currency union requires some ceding of national sovereignty.”
Nationalists want control over Scotland’s finances while maintaining a currency union. Salmond and his semi-autonomous government in Edinburgh said on Nov. 26 that Scotland has a proportional claim to the pound and central bank. Prime Minister David Cameron’s government has said a union won’t work because the risks would be too great in the event of a fiscal shock.
“Carney today highlights the principled difficulties of entering a currency union,” a U.K. Treasury spokesman said in an e-mailed statement. “In the event of independence, a currency union is highly unlikely to be agreed.”
The Scottish government currently has control over policy areas including health, transportation, justice and education with money transferred from London. The U.K. dictates the broader economy and spending, defense and foreign affairs.
While opinion polls this week showed the first significant movement toward favoring independence, more voters in Scotland say they’d prefer to stick with the status quo.
In his final speech before leaving the Bank of Canada last year to cross the Atlantic, Carney told an audience in Quebec that Canada’s monetary union had helped foster prosperity. The French-speaking province voted twice, in 1980 and 1995, on independence and both times opted to stay part of Canada.
An arrangement to retain sterling would need to be negotiated between the Westminster and Scottish Parliaments, and the Bank of England would be part of the process of implementing it, Carney said in a speech hosted by the Scottish Council for Development & Industry.
The Bank of England will provide “technical advice and context” to the decision makers, he said. It wasn’t for the central bankers to judge on political matters, he said.
European officials have accepted that monetary union won’t be complete until there is some pooling of fiscal sovereignty, with options including a transfer union or common employment insurance, Carney said. Any approach will likely involve “significant” sharing of fiscal risk.
“The euro area is now beginning to rectify its institutional shortcomings, but further very significant steps must be taken to expand the sharing of risks and pooling of fiscal resources,” Carney said. “Similar institutional arrangements would be necessary to support a monetary union between an independent Scotland and the rest of the U.K.”
The backstop of bailing out a partner in a currency union raises the risk that governments won’t be prudent with their budgets in the first place, he said.
“At a minimum, this ‘moral hazard’ problem suggests the need for tight fiscal rules, to enforce prudent behavior for all in the union, although credible sanctions for breaking those rules are hard to develop,” he said.
Even as policy makers work to remove the danger that taxpayers are forced bail out banks that are too big to fail, some link between lenders and nations will persist, Carney said.
The size of the banking industry in an independent Scotland amounts to 12.5 percent of gross domestic product, compared with 4.3 percent of the rest of the U.K., Carney said, citing data from 2012. By comparison, he said financial institutions were equivalent to 7.1 percent of GDP in Ireland in 2007 and 7.4 percent in Iceland, countries that suffered two of the worst banking crises in Europe as credit dried up.
“The existing banking union between Scotland and the rest of the U.K. has proved durable and efficient,” Carney said. “These arrangements help ensure that Scotland can sustain a banking system whose collective balance sheet is substantially larger than its GDP.”
The Bank of England is “very targeted” in deploying its lender-of-last-resort facilities, he said.
“There are protections that are taken when we’re putting the sovereign balance sheet on the line,” Carney said. “We’re disciplined in our provision of that” and “quite liberal in the provision of liquidity,” he said.
Politicians should ensure “that Scotland can sustain a banking system whose collective balance sheet is substantially larger than its GDP,” Carney said. “The euro area has shown the dangers of not having such arrangements.”
The pound was little changed at $1.6567 at 3:05 p.m. London time. It climbed to $1.6668 on Jan. 24, the highest since May 2011. The U.K. currency traded at 82.47 pence per euro.
A common currency area will benefit from shared fiscal arrangements, Carney said. These can help tackle shocks afflicting part of the region and mitigate the loss of exchange rate flexibility. Other positives include reduced uncertainty, deeper financial markets and labor mobility, Carney said.
“Being in a currency union can amplify fiscal stress for individual nations,” he said. “It makes sense to share fiscal risks across the whole currency area.”
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