People in Scotland are heading to the polls today to decide the question of secession. One of the major policy questions for an independent Scotland is whether the country should attempt to keep the pound. As many have now begun to appreciate — with a little help from the eurozone spectacle — this would likely be a big mistake.
In “Euroland’s Original Sin,” Dimitri Papadimitriou and L. Randall Wray explained why a separation between fiscal and monetary sovereignty — when countries do not issue their own currency yet retain responsibility for fiscal policy — is the root of the problem in the eurozone. Any country with this setup will face budgetary constraints to which currency-issuing nations are not subject; the kind of constraints that can generate a sovereign debt crisis if, for instance, the country’s fiscal authority is forced to handle the fallout from a large banking crisis. This is a drum that many people affiliated with the Levy Institute have been banging for some time (well before the eurozone fell into its current mess).
Recently, both Paul Krugman and Martin Wolf have written columns in which they make similar arguments in the context of Scottish independence (and the SNP’s ostensible plan to retain the pound). Philip Pilkington wrote a policy brief a few months ago in which he also argued, with the aid of an analysis of Scotland’s financial balances, that retaining the pound would leave the country open to a eurozone-periphery-style crisis. Pilkington’s story focuses on Scotland’s reliance on oil and gas revenues and the particular instability that could be generated, for a currency-using (vs. issuing) Scotland, by oil price fluctuations.
Although Pilkington suggests it might make sense to retain the pound in the short run (during which time he advocates the use of “tax-backed bonds” to limit instability, a proposal Pilkington originally developed with Warren Mosler [see here and here] for the eurozone), he argues that Scotland ultimately needs to move toward issuing its own freely-floating currency. The question is how to move from the first to the second phase with a minimum of disruption. The policy brief thus lays out a “dual currency” transition plan for Scotland: continue reading…