As the excitement over the Scottish independence referendum (on September 18) heats up, Paul Krugman is getting in on the debate, with an important warning to the new would-be nation.
If an independent Scotland continues to use the Pound, as the leaders of the independence movement hope, then the country would be giving up a key measure of economic security.
Krugman recalls what may be the biggest lesson we’ve learned from the Eurozone crisis, which is that countries that can’t print their own money can get into severe sovereign debt crises, while countries that have their own currencies don’t (typically).
A good comparison is the UK vs. Ireland. Both had huge banking systems that required bailouts, but only in the UK (where they could print their own money) were these bailouts done smoothly, without imperiling the stability of the government.
Krugman further demonstrates the importance of having your own currency by comparing Spain and Florida, a comparison he’s made several times in the past. Spain got into severe trouble, because it couldn’t easily backstop its own banks, or provide counter-cyclical fiscal relief to counteract the real estate bust. Florida, on the other hand, didn’t bear the entire burden of its downturn, and because of Federal fiscal backstops, there was no wholesale crisis of the Floridian banking system.
If Spain and the other countries that gave up their own currencies to adopt the euro were part of a true federal system, with shared institutions of government, the recent economic history of Spain would have looked a lot like that of Florida. Both economies experienced a huge housing boom between 2000 and 2007. Both saw that boom turn into a spectacular bust. Both suffered a sharp downturn as a result of that bust. In both places the slump meant a plunge in tax receipts and a surge in spending on unemployment benefits and other forms of aid.
Then, however, the paths diverged. In Florida’s case, most of the fiscal burden of the slump fell not on the local government but on Washington, which continued to pay for the state’s Social Security and Medicare benefits, as well as for much of the increased aid to the unemployed. There were large losses on housing loans, andmany Florida banks failed, but many of the losses fell on federal lending agencies, while bank depositors were protected by federal insurance. You get the picture. In effect, Florida received large-scale aid in its time of distress.
If Scotland doesn’t have its own currency, it will not only be unable to provide a backstop to its banking system, it will be at the whim of UK monetary policy.
If pro-Independence Scottish voters see keeping the pound as a positive, they ought to reconsider.