A long-time risk of simply the possibility of a Yes vote for Scottish independence, let alone the actuality, is that investment would dry up in Scotland, and perhaps in the rest of the UK; deposits and wholesale funding for Scottish banks and other non bank financials would also get re-routed, most likely to the South, but perhaps out of the country altogether. This conraction in funding liquidity would cause lending to fall, certainly in Scotland, but possibly in the South too, and that would compound the confidence-induced fall in demand. As polls narrowed, different versions of this story have popped up in financial research notes, and economic commentary. And the tremors of a confidence shock have started to be felt. A fall in Sterling and the market capitalisation of firms exposed to Scotland, commercial property deals falling through or being made contingent on a No vote, and so on.
If these trends worsen, we are in trouble. Monetary policy is, to a first approximation, now powerless to stimulate further. Rates are stuck at the zero bound, where they have been since 2009. Long rates don’t leave much room for loosening via forward guidance. For reasons best known to itself, the Bank of England’s Monetary Policy Committee decided against further asset purchases: plausibly, the MPC is doubtful as to whether further QE is desirable. (Some of us never thought it did much good anyway.)
What about fiscal policy? Surely that could come to the rescue? Well, this is problematic, for two reasons.
First, with the Coalition’s staying, if not halting of the deficit-reduction plan, the scope for further fiscal expansion on top of what is already being injected, is somewhat limited.
Second, the unravelling of the union makes it much harder to pull off a loosening of discretionary fiscal spending. How would the soon-to-be-unravelled polity agree to any such program? Where would money be spent and on what? Who would be voting on it? Who would own what the money was spent on, if it went towards infrastructure or some other durable? How would the crumbling UK governmental infrastructure, with so much to resolve about its own future, and the division of spoils, spare any high quality decision-making time for a fiscal stimulus package? Would the debt incurred by a stimus package after a Yes vote be treated differently from debt incurred before? Would there be differently stamped debt to finance spending in Scotland? Could the stimulus in different regions therefore be different on that account?
A contraction in liquidity and credit, causing, or accompanying a reduction in spending because of shaken confidence about the institutional framework for the UK, would be a great misfortune in normal times. Trapped at the zero bound with no obvious means of injecting stimulus, it would be a disaster now. And it seems to me that the very impotence of monetary and fiscal policy would be something that would make such a confidence drop more likely to happen. Imagine Japan convulsing over how to split in two right now. Or, er, the Eurozone….