Thursday, January 30, 2014
Currency unions old and new
Posted by David Smith at 04:30 PM
Category: Thoughts and responses

Mark Carney, in his interesting speech on the monetary consequences of Scottish independence, drew on the experince of the eurozone. He cited Robert Mundell's theory of optimum currency areas. His conclusion on the constraints an independent Scotland would face if it continued to use the pound has been widely reported.

He said: "The Scottish government has stated that in the event of independence it would seek to retain sterling as part of a formal currency union. All aspects of any such arrangement would be a matter for the Scottish and UK Parliaments. If such deliberations ever were to happen, they would need to consider carefully what the economics of currency unions suggest are the necessary foundations for a durable union, particularly given the clear risks if these foundations are not in place.

"Those risks have been demonstrated clearly in the euro area over recent years, with sovereign debt crises, financial fragmentation and large divergences in economic performance. 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. In short, a durable, successful currency union requires some ceding of national sovereignty.

"It is likely that similar institutional arrangements would be necessary to support a monetary union between an independent Scotland and the rest of the UK. " His speech is here.

Another potential parallel is Ireland. The Irish pound was created in 1927 and retained its sterling link for half a century. For two decades after the Irish pound was created, Ireland did not even have its own central bank. The sterling link was broken when Ireland joined the European exchange rate mechanism (ERM) and the Irish pound ceased to exist when Ireland joined the euro. The Irish story, which may have some ramifications for Scotland, is here.