Armstrong, Angus, and Monique Ebell. "Scotland's Currency Options". NIESR Discussion Paper, No.415. London: National Institute of Economic and Social Research, 2013.

Armstrong, Angus, and Monique Ebell. "Scotland's Currency Options". NIESR Discussion Paper, No.415. London: National Institute of Economic and Social Research, 2013.

• The choice of currency is essential to the future economic policy of an independent Scotland (2). 
• This currency would need to fit Scotland's unique needs as a hydrocarbon exporter, the immediate need to issue a large amount of debt following independence, and hold its value over the long term to instill confidence in the new Scottish government (2-3).
• The authors assume that Scotland would separate from the UK over the course of 2 years and that it would join the EU at the earliest possible opportunity (5).
• The ambition to join the EU means that Scottish policy has to be directed toward meeting the criteria set out in the Maastricht Treaty (5). 
• Three possible currency choices are considered: retaining the British pound, creating a new 'Scots pound', and adopting the euro. Using either the British pound or the euro would require the permission of the UK or EU, respectively (2). 
• Adopting the Scots pound would give Scotland the greatest autonomy and independence in its monetary policy, as well as enabling the government to respond to unforeseen crises, but would also raise questions over its creditworthiness considering Scotland's sizable debts. Assets would be redenominated into Scots pounds, although this would be difficult for some foreign contracts, considering the complexity of the Scottish financial sector. The Scots pound is a viable option, as many European countries of a similar size to Scotland mint their own currencies. (6-10)
• The Scottish share of foreign currency reserves would be $9 billion, too small to be safe, meaning that Scotland would need to raise reserves. This could be done by trading domestic assets to the Bank of England in exchange for the British pound reserves that currently back money issued in Scotland, by running consistent trade surpluses, and buying printing Scots pounds and selling them on international currency markets (7).
• The new Central Bank of Scotland would need to take on regulatory and fiscal responsibilities currently performed by the Bank of England. Most major banks are likely to relocate their headquarters to London or elsewhere following Scottish independence, in part to avoid requirements that they hold capital reserves in Scots pounds, which would reduce the regulatory burden on the Central Bank (8).
• Scotland would benefit from having a set or pegged exchange rate to establish its creditworthiness, avoid capital flight, and better accumulate foreign reserves. It would make the most sense to peg the Scots pound to the British pound, or possible to a currency basket including the British pound, euro, and US dollar. In either case, monetary policy is likely to mirror that of the Bank of England (8-9).
• Retaining the British pound would avoid the difficulties of transitioning to a new currency and facilitate trade with the UK (9). It would also leave Scotland dependent on British monetary policy and potentially give Britain a large degree of leverage over Scottish fiscal policy, especially during times of crisis (12).
• This arrangement would require either having monetary policy set by the Bank of England, which is controlled by a nonpartisan Monetary Policy Committee in which Scotland would have no say, or by a new central bank established for the purpose (10-11).
• It is unclear whether, within a currency union, the Bank of England would still be responsible for providing liquidity to Scottish banks during times of crisis. Doing so would require Britain to assume responsibility for risk created by Scottish banks holding Scottish sovereign debt, making it a backer of the Scottish government's solvency. In exchange for providing this liquidity, the Bank of England would likely enforce harsh austerity on Scotland during any future crisis and otherwise impose limits of Scotland's fiscal policies (11, 26-27). 
• In the event that a financial crisis did affect Scotland and the Bank of England did not provide liquidity, it would likely cause capital flight followed by the introduction of a new currency for Scotland (12).
• To adopt the euro, Scotland would first have to issue its own currency and then later join the Eurozone after meeting the criteria set out in the Maastricht Treaty, which could be completed in 2 years at the most rapid, but would likely take many more additional years of negotiations (12). Scotland would lose fiscal autonomy upon adopting the euro, but less so than if it retained the British pound (14).
• The Maastricht criteria that a government must meet to join the Eurozone are a consumer inflation rate not more than 1.5% higher than the inflation rates of the three Eurozone states with the lowest inflation, government deficits less than 3% of GDP, government debt no greater than 60% of GDP, long term interest rates set not more than 2% higher than the rates of the three Eurozone states with the lowest long term interest rates, and successfully maintaining exchange rate stability with the euro for 2 years (13).
• Transaction costs for trade with the UK would be higher with the euro than with the British pound, although they would not be as high as with the Scots pound (13).
• Upon joining the Eurozone, Scotland's monetary policy would come under the control of the European Central Bank. This would likely be against the best interests of Scotland, which would face many of the pressures that Ireland faces, and would require active countercyclical intervention and tight fiscal policy to counteract (13-14).
• Scotland would likely benefit from the ongoing process of integration occurring in the EU, as the responsibilities for banking regulation, providing reserves for balance of payments crises, and liquidity provision are all being taken over by the EU and would no longer be the responsibility of the Scottish government (14).
• From page 6.
• Scotland would have a large amount of debt upon gaining independence, largely from receiving its per capital proportion of British debt. Borrowing costs for the Scottish government, even if it retained the British pound, would be significantly higher than British borrowing costs, making it more difficult for Scotland to finance this debt. In order to remain within the debt-to-GDP ratio defined in the Maastricht Treaty, Scotland would have to run a 3.1% budgetary surplus to finance this debt, requiring a budgetary cut of 5.4% to offset the current pattern of chronic Scottish budget deficits (3, 34-35). Budgetary models for meeting the necessary surplus are given on page 34.
• The debt situation becomes more difficult in the case of greater British indebtedness prior to independence, reduced Scottish control over oil and gas deposits, a decline in oil prices, or an economic recession (3-4).
• If the Scottish debt burden is exceptionally large or unmanageable due to extant circumstances, then Scotland should strongly consider adopting its own currency because this allows it to pursue a greater range of monetary policy to lessen the immediate impact on indebtedness on the economy. This increased risk of creditworthiness could potentially be offset by backing public debt with future oil and gas revenues (4).
• Scottish independence would necessitate creating a new central bank, a national financial regulator, a debt management office, a financial ministry, a revenue and customs office, and independent capital markets (5).
• There are three different types of currency unions: unequal size, in which one country controls the central bank and allows other dependents to use that currency for convenience, with no coordination of fiscal policy; equal size, in which multiple countries agree on a common central bank and jointly control their currency, but still maintain separate fiscal policies; and within countries, where states or other subnational units have some fiscal autonomy, but there is a single currency and a single national banking system (10).
• Since the 1980s, the suddenness and severity of financial crises has increased, largely as a result of the increased role of financial markets in responding to these crises. Worries about the solvency of governments or investments can lead to sudden and massive capital flight, rapidly depreciating currency value, and making existing debts much more difficult to repay. These crises are extremely economically damaging, with an average increase of debt by 21.4% and a 33% loss in future growth (17-18).
• Scotland has a large banking sector and a high debt burden, meaning that it could be potentially overwhelmed with debt in the case of a banking crisis. Having the Scots pound would expose Scotland to exchange rate risk during these crises (36).
• The severity of these crises mean that Scotland should focus more on preventing capital flight and ensuring favor in financial markets than it should on other factors, like trade flows (18).
• Most analyses of Scotland's future currency use 'optimal currency area' theory, which is deeply flawed because it does not take balance of payments crises into account (14-15). Some of the math the egghead authors used is on page 17.
• Optimal currency area theory begins with the assumption that the main benefit of having the same currency is that transaction costs are lower, whereas the main drawback is being unable to respond to economic imbalances between localities or regions. The positive aspects of a currency union are maximized if that involved countries have the same basic business cycles, if wages and prices are flexible, and if capital and labor markets are mobile and can thus respond to regional inequalities (15).
• The flaws of optimal currency area theory are that it does not rank the priority of different factors in determining the viability of currency union, it ignores financial markets and capital flows, and it does not deal with the negative effects of increased trade flows or their effect on consumption (15-16). 
• The affects of Scotland abandoning the British pound are unclear, but are unlikely to have a drastic negative effect on crossborder trade and any such effect would be small during any given year (16).
• Scottish independence would require the division of shared assets and liabilities between the new Scottish government and the remainder of the UK, including public debts and oil and natural gas reserves (19).
• There are very few examples of consensual separation of countries with significant shared assets and liabilities, the exceptions being Czechia and Slovakia in 1993 and preparations for the abortive independence of Quebec in 1995 (19).
• Czechia and Slovakia divided their natural resources on the basis of territory, with resources belong to the state on that side of the border. Their financial assets and liabilities were split on a per capita basis, with the more populous Czechia receiving 2/3s of these financial assets and liabilities (19).
• Oil and natural gas reserves are the most important shared asset, as exploitation of these fields provides 200,000 jobs, roughly 8% of all Scottish employment, and state revenue of 9.49 billion pounds, a full 20% of the Scottish budget. Going by geographic line, around 90% of these fossil fuel reserves would be in an independent Scotland (20)
• Dependence on revenues from oil and natural gas would introduce a great deal of volatility into the Scottish budget, as the value of these outputs fluctuates significantly as prices change, sometimes resulting in changes in excess of 5% of GDP. These fluctuations will also effect the underlying cost of goods and exchange rates between Scotland and other countries (20-21).
• Division of British debt is likely to occur on either a per capita basis, in which case Scotland would receive 8.4% of British debt, or on a proportion of GDP basis, which would be marginally higher. In both cases, Scotland would take on a large portion of debt, likely amounting to 1.82 trillion pounds, or 86% of GDP (23-25).
• It is assumed, based on the criteria set out in the Maastricht Treaty, that current UK debt is at 101% of GDP and that Scotland would receive a portion of this debt (22-23).
• There could be multiple ways of dividing the debt burden. One would be for Scotland to pay the rump UK fees based on interest payments on its portion of the debt as well as additional funds to eventually pay off the principle. This, however, would leave the UK bearing the sole and final responsibility for the debt burden (25). Another alternative would be a debt swap where Scotland pledges future revenues from oil and gas to the UK (26, 37).
• Scotland would presumably inherit some of the Bank of England's foreign currency reserves and British pound reserves following independence (26).
• The fact that Scotland would be an oil exporter, whereas the rest of the UK would remain an oil importer would introduce different market cycles between the countries that would undermine an optimal currency area. If oil prices increases, Scotland's trade surplus would increase whereas the rump UK would experience a trade deficit, to which the Bank of England would likely respond by lower interest rates (21).
• Retaining the British pound would be difficult because of the divergent responses of Scotland and the rump UK to energy market cycles, as monetary policy would respond to England's needs, not Scotland's. This would be reflected in lowered interest rates during trade surpluses and higher interest rates during trade deficits, to the detriment of the Scottish economy, and likely contributing to the problems of 'Dutch disease' (21-22).
• Estimating the possible bond yield rate on Scottish government debt requires some math that these nerds actually did. Overall, the bond yield rate would likely be between 4.82% and 5.75%, both of which are significantly higher than bond yields for the UK or most EU states (30-33).
• Countries generally have much lower interest rates on their sovereign debt if they issue their own currency (28).
• The authors endorse the adoption of a Scots pound as an independent currency, as it gives Scotland the greatest flexibility in response to potential financial crises and the negative impact on trade is likely overestimated. Any solution would have to assure creditworthiness, likely through budgetary austerity; the authors also endorse reducing the size of the debt by selling rights to future oil and gas revenues (38).