In January, we created a very short quiz on Scotland’s post-indy economy according to the conditions set by the current Scottish government. You can complete the quiz here.

It was important for us to be as factually correct as possible when outlining the Scottish government’s post-independence approach. This is a challenge when the underlying neoclassical assumptions of the Scottish government are very different from the real-world assumptions we hold.

We used Building a New Scotland: A Stronger Economy with Independence as this is the most recent and detailed outline of their position. The quiz covers what the Scottish government calls “phase one”

During this phase,

“Scotland would continue to use the pound sterling” (p 35, A Stronger Economy with Independence).

A key sentence in A Stronger Economy with Independence (p 32)

“While Scotland is still using sterling, many aspects of monetary policy would continue to be set by the Bank of England.”

We used this quiz to explain what the practical implications are for control of the Scottish economy, principally concentrating on currency, debt, borrowing and financial services during this period, which will follow the official transition period leading to independence.

If you believe we can amend the quiz to better reflect the current Scottish government position, please leave a comment.

We have listed the questions and answers and have expanded on some of the explanations outlined in the quiz below.

Scotonomics Post Indy Economy Quiz

1. Bank Regulation in Scotland: Who’s in Charge?

a. The Scottish government can regulate commercial banks

b. The Scottish government can not regulate commercial banks

EXPLANATION: All commercial banks operating in Scotland will be regulated under the current UK-wide framework overseen by the Bank of England and the Prudential Regulation Authority (PRA). (3) This includes the creation of credit/bank money. The regulator will directly influence how much money banks create by issuing loans to individuals and businesses and what type of loans they create. This directly affects the Scottish economy.

A Stronger Economy with Independence (p 36) states that a new Scottish Central Bank will “oversee regulatory structures” of financial services, including prudential regulation. It is not clear, but this can not refer to “phase one.” Prudential regulation is a legal framework focused on the financial safety and stability of institutions and the broader financial system. This would have to continue to be carried out at the UK level until Scotland issues its own currency.

2. Government Spending: How Will the Scottish Government spend its budget?

a. The Scottish government could spend money and then tax and borrow to account for all or some of that expenditure

b. The Scottish government must borrow from the Bank of England or international money markets to spend beyond tax receipts

EXPLANATION: A currency-issuing government like the UK, USA, Canada, Japan, Australia, New Zealand, etc., creates currency when they spend; this is how all government bills are paid. They do not need to account for or offset this spending with taxation or borrowing (NB taxes and bonds do not fund government spending as a currency issuer). (1) A country that uses a currency must tax and borrow before it spends, raising every unit of foreign currency. (2)

3. Government Priorities: Creating Jobs and Controlling Prices.

a. The Scottish government can spend what is necessary to achieve full employment and price stability

b. The Scottish government cannot spend whatever is necessary to achieve full employment with price stability

EXPLANATION: Without the ability to create currency, the Scottish government will be unable to spend into the economy to achieve policy goals, for example, full employment. It can borrow foreign currency or rely much more heavily on the private sector to ensure full employment.

4. Government Borrowing: Setting the Interest Rate

a. The Scottish government will choose the interest rate to pay on government bonds

b. The Scottish government must pay an interest rate determined by foreign governments and/or international money markets

EXPLANATION: When issuing your own currency, the policy rate (or the price of borrowing money) is set by the government or, in most cases, the Central Bank, (4) a department of the central government. When the Scottish government borrows money, it will take out a foreign loan. The interest rate isn’t up to Scotland but rather decided by those lending the money, like a bank choosing your loan’s interest rate.

5. Paying Interest on Government Debt: Can Scotland Always Pay Up?

a. The Scottish government will be able to make any payment on time and in full to government bondholders

b. The Scottish government will run the risk of default on its debt

EXPLANATION: A government that pays interest on its debt in the currency it issues can never run out of money. Monetary sovereign governments like the UK, USA, Canada, Japan, Australia, and New Zealand can never go bust as they can always create currency to pay interest. As noted earlier, the rate of interest is set by the central government. On the other hand, when you borrow a currency that you do not create, you can be in a situation where you can not pay that interest.

6. Lender of Last Resort: Can Scotland Save the Day in a Crisis?

a. The Scottish government can act as a lender of last resort to banks, businesses and local authorities

b. The Scottish government can not act as lender of last resort to banks, businesses and local authorities

EXPLANATION: Without its own currency, Scotland can’t just create emergency funds. It would need to ask for help from the Bank of England or international lenders, just like asking a neighbour for a power generator during a blackout. A Scottish central bank or any government department would borrow from someone: it can not be the lender of last resort.

7. Clearing Financial Transactions: Keeping Scotland’s Financial Heart Beating

a. The Scottish government could provide the day-to-day monetary operations to financial services and other large institutions to ensure a functioning finance sector

b. The Scottish government could not provide the day-to-day monetary operations to financial services and other large institutions to ensure a functioning finance sector

EXPLANATION: Clearing payments is one of the central functions of a Central Bank. The Central Bank acts as a short-term creditor to financial institutions. The Bank of England, a UK government organisation, will provide this function. Scotland will have a central bank in name only. Scotland would depend on the Bank of England to provide the day-to-day monetary operations to financial services and other large institutions to ensure a functioning finance sector.

References