Mobility of capital can also promote necessary adjustment to shocks. Moreover, if capital in one part of a union is owned by those in other parts, the effect of a given shock is diluted across the union. Simply put, risks and rewards are shared. Similarly, the ability to borrow from other parts of the currency union in deep and liquid cross-union credit markets or integrated banking systems allows one part of a union to smooth out temporary falls in incomes.19 However, free movement of capital can be a mixed blessing. If the funds provided by one part of a union to another can be withdrawn easily, these outflows can – if the right structures are not in place – undermine financial and economic stability of all members. This brings me to the second feature of a successful currency union – banking union. Banking union Effective currency unions need a wide range of institutions to support an integrated and efficient financial sector. These are often referred to as a “banking union” and include: •  Common supervisory standards,  •  Access to central bank liquidity and lender of last resort facilities,  •  Common resolution mechanisms, and  •  A credible deposit guarantee scheme. Without a banking union, cross-border capital flows can be restricted, the effectiveness of monetary policy impaired and, in the extreme, the viability of the union itself undermined.
Scots have shaped the modern world through their contributions to culture and science. The pioneering work of Scottish economists from Adam Smith to Sir James Mirrlees has had great influence on my profession. Among them is David Hume, born just a short walk from here and a great friend and collaborator of Smith. While better known as a philosopher, Hume’s essay “Of the balance of trade” set out the theory of how trade imbalances between nations sharing a currency (gold) would self-correct as inflows of money to surplus countries raised their prices and reduced their competitiveness. As an empiricist, Hume would doubtless admit that recent euro area experience of persistent current account deficits leading not to self-correction but instead to crisis requires a more elaborate explanation. Fortunately economists have over the years obliged with substantial work on the economics of currency unions. Given the recent focus here on the currency and the fundamental role of the Bank of England in maintaining monetary and financial stability across the United Kingdom, I want to draw on that body of economics today to review some of the most important issues with respect to monetary union. I will stick rigidly to what Thomas Carlyle described as the dismal science. Any arrangement to retain sterling in an independent Scotland would need to be negotiated between the Westminster and Scottish Parliaments. The Bank of England would implement whatever monetary arrangements were put in place.