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No dollar for Quebec: Financial Post Op-ed


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March 19, 2014

Published in the Financial Post on March 19, 2014

By Steve Ambler

The UK’s arguments against Scotland using the pound also apply to Canada and Quebec

Quebec’s current premier, Pauline Marois, has launched an election clearly aimed at setting the stage for a fresh referendum on Quebec’s status within Canada.

And the entry of star candidate Pierre-Karl Péladeau has renewed speculation over possible monetary arrangements between Quebec and the rest of Canada. Premier Marois said that Quebec could keep the dollar and, imaginatively, that “we may wish to get a seat at the Bank of Canada.”

The federal government’s response, and the Bank of Canada’s so far, has been to remain quiet and hope the problem goes away, along with imaginative claims. This is wrong.

On September 28 this year Scotland will be holding its own referendum on independence. The UK Treasury and the Bank of England have been rather more forthright than their Canadian counterparts. The Bank and Treasury delivered a one-two-three punch in the form of a speech by Governor Mark Carney in Edinburgh on January 29, another by Chancellor of the Exchequer George Osborne on February 23, and an open letter from Sir Nicholas MacPherson, Permanent Secretary to the Treasury, on February 14.

Carney billed his speech as “a technocratic assessment of what makes an effective currency union between independent nations.” He reviewed the criteria for a successful currency union without passing judgement on whether a currency union between Scotland and the rest of the UK would meet them.

Among the criteria is that currency unions must be negotiated. That makes sense, because to give up an independent monetary policy and flexible exchange rate, which absorb economic shocks, would entail costs for all parties. A banking union is crucial, including a role as lender of last resort for the central bank, a common deposit insurance system, and a common fiscal backstop so that the central bank can carry out its lender-of-last-resort role.

Bluntly, “a durable, successful currency union requires some ceding of national sovereignty.”

Chancellor Osborne was blunter yet. He elaborated on Carney’s speech, and concluded that the currency union issue “more than any other exposes the gaping chasm at the core of the plans to separate Scotland from the rest of the UK.” On the basis of Treasury analyses, he could not recommend a currency union. “If Scotland walks away from the UK, it walks away from the UK pound.”

MacPherson’s letter was the zinger. He “would advise strongly against a currency union as currently advocated, if Scotland were to vote for independence,” and stressed four points.

First, a currency union means serious commitment. Second, the UK would bear all of the liquidity and solvency risks associated with the Scottish banking system. Third, Scotland and the rest of the UK would be find themselves politically unbalanced and untenable: The rest of the UK could provide support, including taxpayer support, to the Scottish financial sector and government.

On the other hand, “An independent Scottish state would not face the same risk, as it is inconceivable that a small economy could bail-out an economy nearly 10 times its size.” And what if Scotland runs into trouble? MacPherson was clear: “If the dashing of Scottish expectations were perpetually blamed on continuing UK intransigence within the currency union, relations between the nations of these islands would deteriorate, putting intolerable pressure on the currency union.”

MacPherson’s arguments apply with force to Canada. Premier Marois’s suggestion that Quebec could use the Canadian dollar and “might” ask for a seat at the Bank of Canada, does not show strong commitment. The rest of Canada would indeed bear most of the insolvency and liquidity risks for the banking system in Quebec. The asymmetry in size is not as severe, but still would be important (four to one instead of ten to one).

On the fiscal side, Quebec’s budget deficit is modest for now. But there is a huge spending gulf between Quebec and the rest of Canada: Quebec’s total spending in 2009 was 35% of GDP, the highest of any province except Prince Edward Island. By contrast, the figure for Ontario was 26%, and 20% for Alberta. This clear divergence reflects the “Quebec model” that accords a much greater role for the state.

Further, in 2012 the federal government’s total transfers to Quebec totalled over $16-billion, 4.3% of Quebec’s GDP. Without these transfers, Quebec would begin independence with both high debt and a large deficit. That raises the matter of the “independence risk premium.” In Scotland, according to UK Treasury, that would be between 72 and 165 basis points in interest on its government debt. A 100-basis point increase in the costs of borrowing for Quebec would add approximately $2.5-billion to the annual cost of servicing its debt.

The Department of Finance should be as clear about the economics as the UK Treasury. The federal government should not hesitate to make the facts known in forceful terms. Governor Poloz should also undertake a more gentle pedagogical exercise, similar to Governor Carney’s Edinburgh speech.

Quebecers may well choose independence, even if at significant economic cost. Ottawa would fail in its duty to Canadians if it did not take steps to make those costs clear.

Steve Ambler is David Dodge Chair in monetary policy, C.D. Howe Institute, and professor, Département des sciences économiques, Université du Québec à Montréal.

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