Media Briefings


  • Published Date: April 2014

SCOTTISH INDEPENDENCE IN AN INTERDEPENDENT WORLD: New analysis of the implications for financial regulation, fiscal rules and the currency choice

The UK and Scottish governments are engaged in a set of parallel and overlapping games in the economic and political arenas, according to Professor Andrew Hallett, in a study to be presented at the Royal Economic Society’s 2014 annual conference. His research analyses how decisions about whether to cooperate over financial regulation, fiscal rules and the choice of currency and monetary policy will all have far reaching implications for a newly independent Scotland and the rest of the UK (rUK).


Any economy must have a policy framework designed to manage the three basic macro-economic imbalances: the private financing (savings-investment) gap, the public spending-revenues (fiscal) gap, and the foreign financing (trade) gap – implying a need for financial regulation, fiscal rules and a currency/monetary policy choice respectively. A newly independent Scotland would be no exception.


This study is the first, and perhaps only one to examine a framework that recognises the links between these gaps and their interactions; while at the same time analysing the impact on the rest of the UK. Previous studies have analysed particular sections of the Scottish economy in isolation, without recognising their interplay with other sectors or tracing their impact on rUK.


This formal analysis exposes the fact that the UK and Scottish governments are engaged in a set of parallel and overlapping games. A parallel game is where the same opponents play against each other at the same time in more than one arena: in this case, in the political and economic arenas.


An overlapping game is where each player is engaged in a game against different opponents, and where the strategies pursued in one game limit the strategies available in another. This is an economic game where the UK and Scottish governments play against each other, but also against the private sector. It impinges on the political game.


The solution of these games shows how the threat points – the best outcomes that each player can expect to achieve without cooperating, accommodating or otherwise making concessions to the other – will alter from their status quo ante position.


For example, the currency choice question poses a dilemma for both governments. Since the UK government cannot prevent Scotland taking the pound if it wishes, nothing changes for Scottish monetary policy if London refuses to share sterling and monetary policy since it doesn’t share them now.


Given independence, the only difference would be that Scotland would get to add tax powers to the existing monetary set-up. So it would be unambiguously better off: more policy instruments to serve the same targets, instruments that can be designed to fit Scotland's specific needs rather than the UK average.


The cost would be no Scottish input into monetary policy, which is to leave things as they are. Since Scotland would at best have one vote in ten in forming monetary policy in a fuller union, blocking that would have no practical effect.


And on regulation, Scotland can ‘opt-in’ to the EU banking union, giving her financial sector better access to the Euro-markets and a wider pool of resolution funds. The threat point of the economic game has shifted, with consequences in the political game because blocking monetary cooperation makes a wider political union look risky and less attractive.


But rUK will be worse off; no better off since monetary policy would be set in exactly the same way as now, but worse off to the extent Scotland uses her new tax powers to her own advantage rather than rUK’s; also because rUK would lose tax revenues.


The link to fiscal deficits/debt is now obvious. The loss of fiscal transfers from London will be more than compensated by the return of tax powers, meaning a diversified set of revenues and fully functioning automatic stabilisers supplemented by an oil fund to stabilise energy revenues. Also, research shows the bulk of risk sharing in mature currency unions is borne by cross-border asset holdings and loans; that is, it is preserved if the currency is maintained.


The fiscal deficit itself, if existing forecasts based on current practice are correct, would have oil revenues (still positive, if falling) added to it, plus repatriated taxes from commuters, from eliminating pension payment subsidies, and lower debt interest payments to rUK – implying a surplus over current payments.


That in turn provides the link to credit markets. If the existing models predicting risk premia for Scotland are correct, then the absence of material fiscal deficits and debt would lead to interest rates lower than in rUK after an initial period. Combined with a separation of private from public risk (the banking union resolving the former, a fiscal council the latter), this will lead to lower market rates. Similarly, the combined effects of Vickers, conduct regulation, EU regulation and Basel III will reduce the financial assets under Scotland’s supervision to the level of GDP.


As the Standard and Poor’s ratings assessment recognises, independence imposes ‘significant but not unsurpassable’ changes and risks – on both sides.





Notes for Editors:

‘Scottish Independence in an Interdependent World: or the Economics of ‘Post-Truth’ Politics’ by Andrew Hughes Hallett


For further information, contact:

Romesh Vaitilingam:, +44 7768 661095