“Spain without the sunshine”

A noble prize winning economist has warned that: “If Scottish voters really believe that it’s safe to become a country without a currency, they have been badly misled.”

On Saturday, I quoted at length from Oxford economics professor Simon Wren-Lewis’ fisking of the Yes campaign’s fiscal policy. However, it’s its monetary policy which is most reckless.

Paul Krugman is an even more eminent economist than Wren-Lewis. He has been a professor at Princeton for more than a decade, won the Noble Prize for economics in 2008 and is one of America’s most important political pundits. He’s also no fan of the ‘effing Tories’ but nonetheless he warns Scots that:

…the combination of political independence with a shared currency is a recipe for disaster. Which is where the cautionary tale of Spain comes in.

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 lotlike 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, and many 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.

Spain, by contrast, bore all the costs of the housing bust on its own. The result was a fiscal crisis, made much worse by fears of a banking crisis that the Spanish government would be unable to manage, because it might literally run out of cash. Spanish borrowing costs soared, and the government was forced into brutal austerity measures. The result was a horrific depression — including youth unemployment above 50 percent — from which Spain has barely begun to recover.

And it wasn’t just Spain, it was all of southern Europe and more. Even euro-area countries with sound finances, like Finland and the Netherlands, have suffered deep and prolonged slumps.

In short, everything that has happened in Europe since 2009 or so has demonstrated that sharing a currency without sharing a government is very dangerous. In economics jargon, fiscal and banking integration are essential elements of an optimum currency area. And an independent Scotland using Britain’s pound would be in even worse shape than euro countries, which at least have some say in how the European Central Bank is run.

I find it mind-boggling that Scotland would consider going down this path after all that has happened in the last few years. If Scottish voters really believe that it’s safe to become a country without a currency, they have been badly misled.

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