Mark Carney, the Bank of England governor who, of course, used to run the Bank of Canada, attracted attention last week when he used a speech in Edinburgh to wade in on the sensitive subject of Scotland’s upcoming referendum on secession. A Canadian might be inclined to scour Carney’s text for veiled allusions to the possibility of Quebec separation. But, in this case, the Canadian references were overt and not really about our unity anxieties.
Instead, Carney used his familiarity with Canada to add real-world context to a quite technical discussion of what would have to happen for an independent Scotland to keep sharing a currency with Britain. He talked about how Canada, despite having such a regionally varied economy—from oil fields to high-tech centres—manages to function with just the loonie and the same interest rate policy serving the entire, diverse federation.
If you’re at all interested, the whole speech is worth reading. I was struck by one element. Carney stressed that a crucial aspect of sharing a currency within a federation, or a monetary union of any sort, is making sure so-called fiscal stabilizers transfer some wealth from surging to slumping regions. In particular, he points out that “slowing growth in one part of the union causes tax revenues there to fall and welfare spending to increase.”
This sort of automatic transfer of wealth allows any one region to better weather a patch of slow growth, without the need for its own, floating currency to fall as a shock absorber during bad times. Here’s part of what Carney had to say on the subject in Edinburgh:
“Fiscal stabilization is particularly important in a currency union because it helps mitigate the loss of exchange rate flexibility. But being in a currency union can amplify fiscal stress for individual nations, limiting their ability to perform this valuable role just when it is most needed. So it makes sense to share fiscal risks across the whole currency area. A localized shock is less likely to stretch the fiscal position in a larger more diversified currency area, especially if it shifts demand between different parts of the area. That makes a given shock to Nova Scotia less severe than the equivalent to Portugal.”
I’ve heard Carney talk about this before, although not with the Scottish backdrop. In 2011, I asked him in an interview if the crisis then gripping Europe didn’t teach the hard lesson that countries like Greece and Portugal would have been much better off with their own currencies, just as Canada benefited mightily from the Canadian dollar dropping relative to the U.S. dollar back in the 1990s.
Carney said the lesson wasn’t necessarily that small, vulnerable economies should keep their drachmas and lira, but rather that if they join monetary unions, like the EU, they need reliable, Canadian-style fiscal transfers. Here’s part of his answer:
“There’s no question that the exchange rate acts as a shock absorber… In joining a monetary union, you very explicitly give up that lever. There are deeply held political reasons for European monetary union, but the quid pro quo of giving up the exchange rate lever is you better have a quite flexible economy, so that you can adjust to inevitable changes to relative competitiveness.
“You can do it through productivity, flexible wages, people moving across borders as necessary. Just as within the Canadian economy, as the fortunes of different regions change, those adjustments take place in our economy. We have quite a flexible economy… And it’s not just about equalization and transfer payments. Just think about the way the tax system works. We take less taxes out of Alberta when energy prices are down and activity is down, and there’s more transfers to individuals net from the federal purse at that time as well.”
I think we sometimes undervalue the ingenious way the Canadian economy is organized. And when parts of it aren’t doing all that well, we should look first to its inherent strengths—flexibility, mobility, agility—for solutions.