Analysis of Scotland and the Creation of a “Sterling Zone”
The referendum that is scheduled to be put to a vote on September 18th of this year is a very historic one but with it comes the major questions of what Scotland will do with its independence and more specifically what currency will it operate with. The currency issue has been a hot button topic in the political and economic world as both sides argue adamantly about it. Many believe that if Scotland is able to maintain using the pound that the referendum will pass easier as Scottish citizens will feel safer with their countries young economy if it was backed by the historically strong currency of the United Kingdom (UK) but there is opposition to allowing Scotland to remain in the “Sterling Zone” for fear of the risks that would come along with two independent countries entering into a currency union. This report will discuss the costs and benefits for both countries in entering a currency union and the criteria for entering an optimal currency area along with how well the two countries meet those criteria.
Aside from the political implications of keeping the pound, there are many benefits that go along with entering into a currency union. One of these benefits that Scotland desires from this union is to keep the effective central bank that exists currently with the Bank of England; this would be a major benefit to Scotland’s economy because the Bank of England has a history of producing and maintaining a strong currency. Along with an effective central bank, having the same currency would eliminate transaction costs, create price transparency, and alleviate the fear of exchange rate changes for businesses between the countries of Scotland and the UK. There would be an increase in the transaction costs of all of the businesses within Scotland and the UK if the currency were to change as they would need to constantly convert money and even possibly need to set up currency hedges in some cases causing the increase of costs for those business and lowering their net incomes causing the economies of the two countries to be damaged to a degree. These losses to both countries would obviously be eliminated if they were to join a currency union as there would exists no transaction costs of changing currency as there would only be the same currency across the board. Also price transparency would allow companies in both countries to have a better relationship and allow for existing partnerships to continue without the worry of prices or costs changing and with these relationships being continued the economies. Being a part of a currency union would decrease the uncertainty of future exchange rates between countries as with any independent currency of Scotland there would be a fear of drastic changes in the exchange rate when making contracts or conducting deals between businesses in either country. Finally, the last benefit of adopting the pound is that Scotland would be using an internationally recognized currency and the businesses within the country would have an easier time dealing on the ever increasing international market with an established currency like the pound as opposed to a new currency of Scotland’s own.
While there exist many benefits in joining a currency union, they mainly benefit Scotland in the arrangement because they are a smaller economy than that of the UK while the costs of creating a currency union rests largely on the shoulders of the UK causing the current government to oppose the creation of this union. The main cost of maintaining a currency union is the threat of asymmetric shock. This, as Sir Nicholas Macpherson the Permanent Secretary for Her Majesty’s Treasury stated, causes an asymmetry between the two countries meaning that “the continuing UK would be at risk of providing taxpayer support to the Scottish financial sector and sovereign. An independent Scottish state would not face the same risk as it is inconceivable that a small economy