Scotland as an optimal currency area

Abstract

The June 2016 UK referendum on continued EU membership where the people of Scotland voted to remain, while the rest of the United Kingdom voted to leave, once again makes the issue of whether Scotland is an optimal currency area very topical. England voted strongly to leave Europe while Scotland backed remain by 62% to 38%. The Scottish government published its draft bill on a second independence referendum in October 2016. The move does not mean another referendum will definitely be held, but this does raise the possibility that Scotland might choose independence and staying in the EU without the rest of the United Kingdom. If Scotland charts a course of independence from the rest of the United Kingdom, then they would likely either issue their own currency or join or form another currency area. In this paper, we test the microeconomic foundations of a common currency area for Scotland, United Kingdom, and the rest of the United Kingdom without Scotland. We find that the United Kingdom, Scotland, and the United Kingdom without Scotland all meet the microeconomic criteria for a common currency area. In contrast, banking data suggest that lending in Scotland is different from lending in the rest of the United Kingdom, adding some doubt to the issue of whether or not Scotland is a common currency area with the United Kingdom.