Dr Alex Mandilaras, Senior Lecturer in Economics at the University of Surrey, gives his insights into the debate over the potential currency of an independent Scotland.
The Scottish Government is keen to form a "Sterling Area" with the UK post-independence. Ironically, under this arrangement, an independent Scotland would not have an independent monetary policy: the Bank of England would still be responsible for setting the Area's policy interest rate. In contrast, a Scottish Government would have the ability to affect the country's output and employment through its own independent taxing and spending decisions.
However, that very same fiscal policy independence would present a potential risk for the Area as a whole. For example, a substantial increase in Scottish debt could lead to significantly higher borrowing costs. In turn, these could derail the country's budget.
Solutions at that stage would be economically and politically painful. The options would entail either an unpopular bailout by the UK (which, no doubt, would come with austere conditions) or a potentially messy exodus from the stirling area in order to boost competitiveness.
Such dilemmas have been recently faced by countries in the eurozone and Scotland should heed the lessons. Entering a currency union with the UK will require a credible and strict fiscal framework to prevent a future exchange rate crisis. Westminster is unlikely to agree to a currency union without appropriate fiscal brakes, otherwise it will be exposing the UK to risks emanating from Scottish fiscal policies.
If Scotland is unwilling to sign up to that, it should bite the bullet and create its own freely-floating currency. That will also be more commensurate with the aim of political independence.
Dr Alex Mandilaras, 24 April 2013